Mr. Y. Taekachance is considering investing in a new restaurant that will spe- cialize in “haute cuisine fast foods,” such as take-out beef Wellington and Peking duck wing dings. He estimates that the restaurant will have the fol- lowing probability distribution of possible returns:

State of the Economy Probability Rate of Return Recession oe —10%

Moderate recovery A 10%

Boom oo) 30%

Reqgutred:

1. What is the expected return of an investment in the new restaurant?

2. Whatis the total risk (diversifiable and non-diversifiable) associated with the investment in the restaurant? (Round to the nearest one-tenth of a percent.)

3. Mr. Taekachance estimates that the new restaurant's return will have a cor- relation coefficient with the return of a well-diversified portfolio (that is, the market portfolio) of 0.6. What is the restaurant’s non-diversifiable risk (absolute measure)?

4. If the standard deviation of the market portfolio’s return is 15.5%, what is the beta of the new restaurant?

5. If the expected return on the market portfolio—E(k,,)—is 16% and the risk-free rate is 8%, is the new restaurant a value-creating investment? Why or why not?