Question

ABC Co is a company with 15 years of experience and currently implementing project A with expected NPV of 155000 USD and standard deviation of 40000 in its operations. Now the company is thinking of implementing an additional project and considering to invest 40% of its resources into it and to choose between projects B and C. These two projects have the following expected probabilities for NPV

Project B Project C
NPV Probability NPV Probability
135000 0,3 157800 0,35
155000 0,4 147523 0,45
-15000 0,3 -20000 0,2

And also the correlation coefficient between the projects ar as follows:
Correlation coefficients:
A&B A&C
0,21 -0,15

What will your recommendation be if the company's policy is to create lower risk portfolio of projects?

Answer 1

Expected NPV of B=0.3*135000+0.4*155000+0.3*(-15000)=98000

Expected NPV of C=0.35*157800+0.45*147523+0.2*(-20000)=117615.35

Standard deviation of B=sqrt(0.3*(135000-98000)^2+0.4*(155000-98000)^2+0.3*(-15000-98000)^2)=74437.89358

Standard deviation of C=sqrt(0.35*(157800-117615.35)^2+0.45*(147523-117615.35)^2+0.2*(-20000-117615.35)^2)=68958.60666

Standard deviation of portfolio with B=sqrt((60%*40000)^2+(40%*74437.89358)^2+2*60%*40000*40%*74437.89358*0.21)=41984.44458

Standard deviation of portfolio with C=sqrt((60%*40000)^2+(40%*68958.60666)^2+2*60%*40000*40%*68958.60666*(-0.15))=33737.89445

Choose C as it has lower risk