Douglas Keel, a financial analyst for Orange Industries, wishes to estimate the rate of return for two similar risk investments, X and Y, Douglas’s research indicates that the immediate past returns will serve as reasonable estimates of future returns. A year earlier, investment X had a market value of $20,000, and investment Y had a market value of $55,000. During the year, investment X generated cash flows of $1,500, and investment Y generated cash flow of $6,800. The current market value of investments X and Y are $21,000 and $55,000 respectively.
a. Calculate the expected rate of return on investments X and Y using the most recent year’s data
b. Assuming that the two investments are equally risky, which one should Douglas recommend? Why?