The Bartram-Pulley Company (BPC) must decide between two mutually exclusive inve
ID: 2648119 • Letter: T
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:
BPC has decided to evaluate the riskier project at a 12% rate and the less risky project at a 8% rate.
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 _________________ Project B.
If Project B's cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?
_________________
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 CashFlow Probability Net Cash
Flow 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? Round your answers to nearest dollar. Project A Project B Net cash flow $ ________ $ ________What is the coefficient of variation (CV)? ? (to the nearest whole number) CV (to 2 decimal places) Project A $ ________ ________ Project B $ ________ ________
What is the risk-adjusted NPV of each project? 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 _________________ Project B.
If Project B's cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?
_________________
Explanation / Answer
Part A
Project A
Project B
Part B
Project A
Standard deviation = ?variance
= ?235,000
= 484.77
Coefficient of variance = standard deviation /Expected cash flow
= 484.77 / 7050
=0.07
Project B
Standard Deviation = ?variance
?25,975,000
= 5096.57
Coefficient of Variance = standard deviation /Expected cash flow
= 5096.57/7250
= 0.70
Part C
Part D
The portfolio effects from Project B would tend to make it less risky than otherwise. This would tend to reinforce the decision to accept Project B.
Part E
If Project B were negatively correlated with the GDP (Project B is profitable when the economy is down), then it is less risky and Project B's acceptance is reinforced.
Probability Net Cash Inflow Probability * Net Cash inflow Variance = Probability*((CF-Expected cash flow)^2) 0.2 $ 7,000 $ 1,400 $ 500 0.6 $ 6,750 $ 4,050 $ 54,000 0.2 $ 8,000 $ 1,600 $ 180,500 Expected net cash flow $ 7,050 $ 235,000Related Questions
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