TABLE 13-3 Houston Disbursement Profitability Profitability of Houston Disbursement in various economic conditions. Variable wages are 40 percent of revenue, and variable operating costs are 20 percent of TABLE 13-4 Profitability Estimates for New Office Locations This table contains profitability estimates for two possible locations for a new office of Houston Disbursement. Profitability for each is estimated using both strong and weak national economies and high and low oil prices. Four Cotner considered high and low oil prices equally likely. However, she believed the probability of a strong economy was twice that of a weak economy. She did not believe a weak economy was likely to last more than 2 years. Low oil prices, on the other hand, could continue for at least 5 years. Oil prices and the economy were both strong at the moment. It would cost approximately $75,000 to open an office in either San Francisco or Alaska. The costs would be primarily development costs and would be expensed for tax purposes. Fixed assets included in this cost would be under $10,000, and a provision of the tax law allowed expensing up to $10,000 of fixed asset acquisitions. Cotner had approximately $200,000 in- vested in U.S. government securities earning 9 percent, so she would have no diffiulty in getting the $75,000. Case Questions 1. Compute expected return and standard deviation of annual return for each alternative separately. stan- 2. Compute covariance of annual re- turns between the Alaska and Houston offices, and between the California and Houston offices. 3. Compute the expected return and standard deviation for each of the two combinations. 4. Prepare pro forma statements for each new office combined with the Houston office, using each of the four possible conditions. 5. What would you recommend to Cotner? Why? TABLE 13-3 Houston Disbursement Profitability Profitability of Houston Disbursement in various economic conditions. Variable wages are 40 percent of revenue, and variable operating costs are 20 percent of TABLE 13-4 Profitability Estimates for New Office Locations This table contains profitability estimates for two possible locations for a new office of Houston Disbursement. Profitability for each is estimated using both strong and weak national economies and high and low oil prices. Four Cotner considered high and low oil prices equally likely. However, she believed the probability of a strong economy was twice that of a weak economy. She did not believe a weak economy was likely to last more than 2 years. Low oil prices, on the other hand, could continue for at least 5 years. Oil prices and the economy were both strong at the moment. It would cost approximately $75,000 to open an office in either San Francisco or Alaska. The costs would be primarily development costs and would be expensed for tax purposes. Fixed assets included in this cost would be under $10,000, and a provision of the tax law allowed expensing up to $10,000 of fixed asset acquisitions. Cotner had approximately $200,000 in- vested in U.S. government securities earning 9 percent, so she would have no diffiulty in getting the $75,000. Case Questions 1. Compute expected return and standard deviation of annual return for each alternative separately. stan- 2. Compute covariance of annual re- turns between the Alaska and Houston offices, and between the California and Houston offices. 3. Compute the expected return and standard deviation for each of the two combinations. 4. Prepare pro forma statements for each new office combined with the Houston office, using each of the four possible conditions. 5. What would you recommend to Cotner? Why