Question

2 Sharon Company is considering an investment project that has an initial cost of $23,000 and an expected life of 3 years. Annual net cash flows from the project begin 1 year after the initial investment is made and have the following probability distribution:

Probability Net Cash Flows
0.25 $2000
0.50 16000
0.25 10000
Expected CFs = $11000
Sharon evaluates riskier project with CV ≥0.50 at 14% and less risky project with CV <0.50 at 10% rate.
a. Calculate the coefficient of variation (CV) of the project given that expected value of cash flows is $11000.
b. What is the risk adjusted NPV of the project, recommend whether it should be undertaken or not?
(Hint: Coefficient of Variation = SD/Expected Return and
Expected Cash flows can be taken as same for all three years for NPV calculation, risk adjusted NPV will be calculated at 14% or 10% as per the answer in part a.)

Answer 1

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