Assets Investment

Kevin Johnson Paints has been quite successful and has $1,750,000 cash to be invested. Kevin and his management team have developed four potential investments in addition to leaving the cash in a low interest deposit. The four new opportunities are:

1. Purchase some shares of a major supplier (20% risk of total loss, 18% potential return)

2. Invest in the research and development of a new product (35% risk of total loss, 70% potential return)

3. Buy a selection of corporate bonds (8% risk of total loss, 5% potential return)

4. Buy a selection of government bonds (2% risk of total loss, 2.5% potential return)

Leaving the money in a low interest deposit is virtually riskless and has a 1.0% potential return.

Kevin's father had provided Kevin with some guidelines for investment, aimed at diversification and risk management. These are:

1. Invest a maximum of 50% of the total cash in any one of the four new opportunities to ensure some risk control.

2. Invest at least $120,000 in each of the four new opportunities to ensure some diversity.

3. Limit the total potential loss, on average, to $350,000, based on the risk factors indicated.

4. Ensure the highest return possible.

Identify decision variables, objective function and constraints. Solve on excel. Recommend the appropriate mix of the four investments and note how much money, if any, should be left in the low interest deposit. Also, how would this mix change, and what would happen to potential return, if Kevin decided to take a more conservative approach and limit the total potential loss to $200,000.