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	Net Cash Flows	Probability	Net Cash Flows
0.2	$6,000	0.2	$        0
0.6	6,750	0.6	6,750
0.2	8,000	0.2	17,000

BPC has decided to evaluate the riskier project at a 12% rate and the less risky project at a 9% rate.

1. 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: σ_B=$5,444 and CV_B=$0.73.)

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

2. 
   
3. 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		$

Answer 1

Answer a.

Project A:

Expected Annual Net Cash Flow = 0.20 * 6,000 + 0.60 * 6,750 + 0.20 * 8,000
Expected Annual Net Cash Flow = 6,850

Project B:

Expected Annual Net Cash Flow = 0.20 * 0 + 0.60 * 6,750 + 0.20 * 17,000
Expected Annual Net Cash Flow = 7,450

Answer b.

Project A:

Variance = 0.20 * (6,000 - 6,850)^2 + 0.60 * (6,750 - 6,850)^2 + 0.20 * (8,000 - 6,850)^2
Variance = 415,000

Standard Deviation = (415,000)^(1/2)
Standard Deviation = 644

Coefficient of Variation = Standard Deviation / Expected Value
Coefficient of Variation = 644 / 6,850
Coefficient of Variation = 0.09

Project B:

Variance = 0.20 * (0 - 7,450)^2 + 0.60 * (6,750 - 7,450)^2 + 0.20 * (17,000 - 7,450)^2
Variance = 29,635,000

Standard Deviation = (29,635,000)^(1/2)
Standard Deviation = 5,444

Coefficient of Variation = Standard Deviation / Expected Value
Coefficient of Variation = 5,444 / 7,450
Coefficient of Variation = 0.73

Answer c.

Coefficient of variation of Project B is higher than that of Project A; therefore, Project B is riskier.

Project A:

Discount Rate = 9.00%

Net Present Value = -$6,750 + $6,850/1.09 + $6,850/1.09^2 + $6,850/1.09^3
Net Present Value = $10,589

Project B:

Discount Rate = 12.00%

Net Present Value = -$6,750 + $7,450/1.12 + $7,450/1.12^2 + $7,450/1.12^3
Net Present Value = $11,144