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Homework answers / question archive / Risky Cash Flows The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects

Risky Cash Flows The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects

Finance

Risky Cash Flows

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $8,000 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 13% rate and the less risky project at a 8% rate.

  1. What is the expected value of the annual net cash flows from each project? Round your answers to nearest dollar.
      Project A Project B
    Net cash flow $    $   

    What is the coefficient of variation (CV)? (Hint: σB = $5,444 and CVB = 0.73.)
      σ (to the nearest whole number) CV (to 2 decimal places)
    Project A $     
  2.  
  3. What is the risk-adjusted NPV of each project? Round your answer to the nearest dollar.
    Project A   $   
    Project B   $   

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a).

Expected value for a probability distribution is a weighted average of individual values. It is calculated as (p1*c1)+(p2*c2)+(p3*c3)

Annual net cashflow of Project A

= (0.2*6000)+(0.6*6750)+(0.2*8000)= 6850

Annual net cashflow of Project B

= (0.2*0)+(0.6*6750)+(0.2*17000)= 7450

b).

Coefficient of variation is calculated as Standard deviation/mean.

Standard deviation with probability distribution is calculated as: sqrt((summation(x^2*p(x)))-Mean^2)

summation(x^2*p(x))= (6000^2*0.2)+(6750^2*0.6)+(8000^2*0.2)= 47337500

Mean= 6850

Standard Deviation= sqrt(47337500-6850^2)= 644.2049 rounded to 644.

Coefficient of variation= 644.2049/6850= 0.09

c).

From the coefficient of variation, we can see that Project B is riskier, as its CV value is high.

So, Project B is evaluated at 13% and Project A by 8%.

Risk adjusted NPV of Project A= -8000+6850/1.08+6850/1.08^2+6850/1.08^3= $9653.

Risk adjusted NPV of Project B= -8000+7450/1.13+7450/1.13^2+7450/1.13^3= $9591.

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