Question

Problem 11-15
Risky Cash Flows

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	Net Cash Flows	Probability	Net Cash Flows
0.2	$7,000	0.2	$        0
0.6	6,750	0.6	6,750
0.2	8,000	0.2	16,000

BPC has decided to evaluate the riskier project at a 12% rate and the less risky project at a 8% rate.

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

	Project A	Project B
Net cash flow	$	$

What is the coefficient of variation (CV)? Do not round intermediate calculations. (Hint: ?B=$5,097 and CVB=$0.70.)

	? (to the nearest whole number)	CV (to 2 decimal places)
Project A	$
Project B	$

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

Project A		$
Project B		$

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

PROJECT A		PROJECT B
Probability	Net Cash	Probability	Net Cash
	Flows		Flows
0.20	7,000.00	0.20	0.00
0.60	6,750.00	0.60	6,750.00
0.20	8,000.00	0.20	16,000.00
Expected value of annual cash flows
Project A	7050	Using the sumproduct if probablity and Net cash flows
Project B	7250	Using the sumproduct if probablity and Net cash flows
Discount rate	12%
Coefficient of variation
	Std deviation	Coefficient of variation
Project A	485	0.07	Using the formula std deviation/Mean
Project B	5,097	0.70
Risk adjusted NPV
Initial cost	6750
Project A	10,183	Using PV formula with rate as 12% and 3 years
Initial cost	6750
Project A	10,663	Using PV formula with rate as 12% and 3 years
If Project A cash flows is positively correlated with firms cash flows and Project B is negetively
Then we should go eith project A as there is not much difference in NPV
If project B cash flows are negetively correlated with GDP the risk will increase and hence should not be chosen