Question

The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each project has an initial outflow of $7,000 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability distributions:

Project A			Project B
Probability	Cash Flows		Probability	Cash Flows
0.2	$6,750		0.2	$          0
0.6	7,000		0.6	7,000
0.2	7,250		0.2	17,000

BPC has decided to evaluate the riskier project at 11% and the less-risky project at 10%.

1. What is each project's expected annual cash flow? Round your answers to the nearest cent.

   Project A:	$
   Project B:	$

   
   Project B's standard deviation (σ_B) is $5,426 and its coefficient of variation (CV_B) is 0.71. What are the values of (σ_A) and (CV_A)? Do not round intermediate calculations. Round your answer for standard deviation to the nearest cent and for coefficient of variation to two decimal places.

   σA:	$
   CVA:

2. 
   
3. Based on their risk-adjusted NPVs, which project should BPC choose?
   -Select-Project AProject BItem 5
4. 
   
5. If you knew that Project B's cash flows were negatively correlated with the firm's other cash flow, whereas Project A's flows were positively correlated, how might this affect the decision?
   -Select-This would make Project B more appealing.This would make Project B less appealing.Item 6
   
   If Project B's cash flows were negatively correlated with gross domestic product (GDP), while A's flows were positively correlated, would that influence your risk assessment?
   -Select-This would make Project B more appealing.This would make Project B less appealing.

Answer 1

a. Project expected annual cash flows of Project A=0.2*6750+0.6*7000+0.2*7250 =7000
Project expected annual cash flows of Project B=0.2*0+0.6*7000+0.2*17000 =7600

b. Standard Deviation of A =(0.2*(6750-7000)^2+0.6*(7000-7000)^2+0.2*(7250-7000)^2)^0.5=158.1139
CVa =Standard Deviation of A/Project expected annual cash flows of Project A =158.1139/7000=0.02

c. NPV of risk adjusted A =PV of Cash flows-Initial Investment =7000*((1-(1+11%)^-3)/11%)-7000 =10106.00
NPV of risk adjusted B =PV of Cash flows-Initial Investment =7600*((1-(1+11%)^-3)/11%)-7000 =11572.23
Project B should be chosen

d. This would make Project B more appealing.

e. This would make Project B more appealing