Question

The MB Company is considering investment in one of the following mutually exclusive projects.Cash inflows of foreseeable next four years are given below (cash inflows 000 dollars)

Probabilty Project K Project L

0.15 4250 4250

0.2 4750 5250

0.3 5250 6250

0.2 5750 7250

0.15 6250 8250

Answer 1

Expected Cash inflows

Expected cash inflows=Sum(probability*cash inflows)

Project K=0.15*4250+0.20*4750+0.30*5250+0.20*5750+0.15*6250=5250.00

Project L=0.15*4250+0.20*5250+0.30*6250+0.20*7250+0.15*8250=6250.00

Standard deviation

Standard deviation=Sqrt(Sum(probability*(cash inflows-expected cash inflows)^2))

Project K=sqrt(0.15*(4250-5250.00)^2+0.20*(4750-5250.00)^2+0.30*(5250-5250.00)^2+0.20*(5750-5250.00)^2+0.15*(6250-5250.00)^2)=632.46

Project L=sqrt(0.15*(4250-6250.00)^2+0.20*(5250-6250.00)^2+0.30*(6250-6250.00)^2+0.20*(7250-6250.00)^2+0.15*(8250-6250.00)^2)=1264.91

Coefficient of variation=Standard deviation/Expected cash inflows

Coefficient of variation

Project K=632.46/5250.00=0.12

Project L=1264.91/6250.00=0.20

Higher coefficient of variation means higher risk hence Project L is more risky

Factors to be considered is the initial investment and therefore NPV (using risk adjusted discounted rate)