Question

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:

Project A		Project B
Probability	Cash Flows	Probability	Cash Flows
0.2	$5,000	0.2	$        0
0.6	6,750	0.6	6,750
0.2	7,000	0.2	20,000

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

1. What is the expected value of the annual cash flows from each project? Do not round intermediate calculations. Round your answers to the nearest dollar.

   	Project A	Project B
   Net cash flow	$	$

   What is the coefficient of variation (CV)? (Hint: σ_B=$6,521.89 and CV_B=$0.81.) Do not round intermediate calculations. Round σ values to the nearest cent and CV values to two decimal places.

   	σ	CV
   Project A	$
   Project B	$

2. What is the risk-adjusted NPV of each project? Do not round intermediate calculations. Round your answers to the nearest cent.

   Project A:		$
   Project B:		$

3. If it were known that Project B is negatively correlated with other cash flows of the firm whereas Project A is positively correlated, how would this affect the decision?

   This would tend to reinforce the decision to -Select-acceptrejectItem 9 Project B.

   If Project B's cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?

   -Select-YesNoItem 10

Answer 1

1.
Net cash flow
Project A=0.2*5000+0.6*6750+0.2*7000=6450.000

Project B=0.2*0+0.6*6750+0.2*20000=8050.000

2.
Standard deviation
Project A=sqrt(0.2*(5000-6450)^2+0.6*(6750-6450)^2+0.2*(7000-6450)^2)=731.437

Project B=sqrt(0.2*(0-8050)^2+0.6*(6750-8050)^2+0.2*(20000-8050)^2)=6521.886

3.
CV
Project A=731.437/6450=0.113

Project B=6521.886/8050=0.810

4.
Risk adjusted NPV
Project A=-6750+6450/10%*(1-1/1.1^3)=9290.195

Project B=-6750+8050/11%*(1-1/1.11^3)=12921.903

5.
Accept

6.
Yes