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	$6,250		0.2	$0
0.6	6,500		0.6	6,500
0.2	6,750		0.2	18,000

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

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 (?_B) is $5,822 and its coefficient of variation (CV_B) is 0.78. What are the values of (?_A) and (CV_A)? Round your answer to two decimal places.

?_A = $

CV_A =

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

-Select-Project AProject 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?

-Select-This would make Project B more appealing.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?

th the firm's other cash flows, but Project A's cash 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.

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?

Answer 1

O1) Calculation of expected annual cash flow:

Project A:

Probability	Cash flow	Expected Value
0.2	6,250	1,250
0.6	6,500	3,900
0.2	6,750	1,350
	EV	6,500

Project B:

Probability	Cash flow	Expected Value
0.2	0	0
0.6	6,500	3,900
0.2	18,000	3,600
	EV	7,500

2, Calculation of standard deviation:

Project A:

Probability	Cash flow	Expected Value	D= CF-EV	D2	P X D2
0.2	6,250	1,250	-250	62,500	12,500
0.6	6,500	3,900	0	0	0
0.2	6,750	1,350	250	62,500	12,500
	EV	6,500		Total	25,000

Or,   = $158.11

Co efficient by variation = Standard deviation/Mean

= 158.11/6,500 = 2.43%

3) DCF Analysis:

Project A@9%:

Year	Cash flows	PVF	PVFA
0	0	1	0
1	1250	0.917	1146.25
2	3900	0.842	3283.8
3	1350	0.772	1042.5
		DCF	5472.55

NPV = 5472.55-6500= ($1027.45)

Project B@13%:

Year	Cash flows	PVF	PVFA
0	0	1	0
1	0	0.885	0
2	3900	0.783	3054
3	3600	0.693	2495
		DCF	5549

NPV = 5549-6500= ($951)

If its a choice between these two projects only then Project B should be chosen as it has lesser negative NPV.

4. a) This would make project B less appealing as firm would not want other cash flows to get negative affected.

b) Most firms would not care and go ahead with Project B, however in the interest of country, Project A should be taken forward.