Question

ch 12

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	$6,500		0.2	$          0
0.6	7,000		0.6	7,000
0.2	7,500		0.2	19,000

BPC has decided to evaluate the riskier project at 13% and the less-risky project at 9%.

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 $6,132 and its coefficient of variation (CV_B) is 0.77. 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.Item 7

Answer 1

a. Expected annual cash flow of Project A =0.2*6500+0.6*7000+0.2*7500 =7000
Expected annual cash flow of Project b =0.2*0+0.6*7000+0.2*19000 =8000

b. σ_A =(0.2*(6500-7000)^2+0.6*(7000-7000)^2+0.2*(7500-7000)^2)^0.5 =316.23
CVa =Standard Deviation/Expected Return =316.23/7000=0.05

c. A is less risky at 9%
B is more risk at 13% This is because B has higher coefficient of variation
NPV of A =PV of Cash Flows -Initial Investment =7000*(1-(1+9%)^-3)/9%-7000=10719.06

NPV of B =PV of Cash Flows -Initial Investment =8000*(1-(1+13%)^-3)/13%-7000=11889.22
Project B must be selected.

d. This would make Project B more appealing.

e.This would make Project B more appealing