Question

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $7,750 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	$6,000	0.2	$        0
0.6	6,750	0.6	6,750
0.2	8,000	0.2	15,000

BPC has decided to evaluate the riskier project at a 13% 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=$4,758 and CV_B=$0.67.) 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-YesNo

Answer 1

1.
=0.2*6000+0.6*6750+0.2*8000=6850

2.
=0.2*0+0.6*6750+0.2*15000=7050

3.
Project A standard deviation=SQRT(0.2*(6000-(0.2*6000+0.6*6750+0.2*8000))^2+0.6*(6750-(0.2*6000+0.6*6750+0.2*8000))^2+0.2*(8000-(0.2*6000+0.6*6750+0.2*8000))^2)=644.204936336256

4.
Project A CV=SQRT(0.2*(6000-(0.2*6000+0.6*6750+0.2*8000))^2+0.6*(6750-(0.2*6000+0.6*6750+0.2*8000))^2+0.2*(8000-(0.2*6000+0.6*6750+0.2*8000))^2)/(0.2*6000+0.6*6750+0.2*8000)=0.0940445162534681

5.
Project B Standard deviation=4758

6.
Project B CV=0.67

7.
=-7750+6850/10%*(1-1/1.1^3)=9284.9361

8.
=-7750+7050/13%*(1-1/1.13^3)=8896.1258

9.
Reject

10.
Yes