Question

The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $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	18,000

BPC has decided to evaluate the riskier project at 11% and the less-risky project at 8%.

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

   Project A $

   Project B $

   Project B's standard deviation (σ_B) is $5,776 and its coefficient of variation (CV_B) is 0.74. What are the values of (σ_A) and (CV_A)? Round your answer to two decimal places.

   σ_A = $

   CV_A =

2. Based on the risk-adjusted NPVs, which project should BPC choose?

   Project A or Project B

3. 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?

   This would make Project B more appealing or This would make Project 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? This would make Project B more appealing or This would make Project B less appealing.

Answer 1

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