Question

The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,500 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 $6,000 0.2 $0

0.6 $6,500 0.6 $6,500

0.2 $7,000 0.2 $17,000

BPC has decided to evaluate the riskier project at 11% and the less-risky project at 9%.

QA. What is each project's expected annual cash flow? Round your answers to two decimal places.

Project A $

Project B $

QB. Project B's standard deviation (σB) is $5,464 and its coefficient of variation (CVB) is 0.75. What are the values of (σA) and (CVA)? Round your answer to two decimal places.

σA = $

CVA =

Based on the risk-adjusted NPVs, which project should BPC choose? Options are: Project A or Project B

If you knew that Project B's cash flows were negatively correlated with the firm's other cash flows, but Project A's cash flows were positively correlated, how might this affect the decision? Options are: B more appealing or B less appealing

If Project B's cash flows were negatively correlated with gross domestic product (GDP), while A's cash flows were positively correlated, would that influence your risk assessment? Options are: B is more appealing or B is less appealing

Answer 1

Q A. Expected Annual Cash Flow =0.2*6000+0.6*6500+0.2*7000 =6500
Expected Annual Cash Flow =0.2*0+0.6*6500+0.2*17000 =7300

QB. Standard Deviation of A =(0.2*(6000-6500)^2+0.6*(6500-6500)^2+0.2*(7000-6500)^2)^0.5 =316.23
Coefficient of Variation =Standard Deviation of A/Expected Annual Cash Flow =316.23/6500 =0.05

QC. Project B is more appealing (Negative correlation causes the standard deviation of portfolio are different)
Project B is more appealing (Negative correlation causes the standard deviation of portfolio are different)