Question

Consider the probability distribution of the first year cash flows for the ABC Project:
Possible Cash
flow
Probability
$1,000 15%
$2,000 75%
$3,000 10%
i). What is the most likely outcome? (1 mark)
ii) Calculate the range of possible cash flows. (1 mark)
iii). Calculate the expected cash flow.
iv). Calculate the standard deviation of the possible cash flows.
v). Calculate the coefficient of variation of the possible cash flows.(1 mark)

Answer 1

i) Most likely outcome (with highest probability) = $2000

ii) Range of possible cashflows =maximum -minimum = $3000 - $1000 = $2000

iii) Expected Cashflow = probability weighted cashflows

= 0.15*$1000 + 0.75*$2000+ 0.10*$3000

=  $1950

iv)

where p_i represents the individual probabilities in different scenarios

R_i represents the corresponding returns in different scenarios and

represents the expected return calculated as above.

= sqrt(0.15*(1000-1950)^2+0.75*(2000-1950)^2+0.10*(3000-1950)^2)

=sqrt (247500)

=$497.49

v) Coefficient of variation = standard deviation of cashflows/ expected cashflows

= 497.49/1950

=0.255