Text book problems: Chapter 12 Problem 12-7 page 28 Fundamentals of Financial Ma
ID: 2716415 • Letter: T
Question
Text book problems: Chapter 12 Problem 12-7 page 28 Fundamentals of Financial Management 14th Edition
Scenario Analysis. Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be "average". However, the CFO realizes that conditions could be better or worse , so she perfomed a scenario analysis and obtained these results:
Economic Scenario Probability of outcome NPV
Recession 0.05 ($70 million)
Below average 0.20 ($25 million)
Average 0.50 12 million
Above average 0.20 20 million
Boom 0.05 30 million
Calculate the project`s expected NPV, standard deviation, and coefficient of variation.
Explanation / Answer
Expected NPV = $ 3 Million
Standard Deviation = $ 23.62 Million
Coefficient of Variation = 7.873
(Amount in $ Millions)
Economic Scenario
Probability
NPV
Proability * NPV
Recession
0.05
-70
-3.5
Below Average
0.20
-25
-5
Average
0.50
12
6
Above Average
0.20
20
4
Boom
0.05
30
1.5
Expected NPV = -3.5-5+6+4+1.5 = $ 3 Million
Variance = 0.05 * (-70-3)^2 + 0.20 * (-25-3)^2 + 0.50*(12-3)^2+0.2*(20-3)^2+0.05*(30-3)^2
= 0.05*(-73)^2+0.2*(-28)^2+0.5*9^2+0.2*17^2+0.05*27^2
= 0.05*5329 + 0.20 * 784 + 0.50*81 + 0.20 * 289 + 0.05*729
= 266.45 + 156.80 + 40.5 + 57.8 + 36.45
= 558
Standard Deviation = Square Root (558) = 23.622 or $ 23.62 Million
Coefficient of Variation = Standard Deviation / Mean = $ 23.62 Million / $ 3 Million
= 7.873
Economic Scenario
Probability
NPV
Proability * NPV
Recession
0.05
-70
-3.5
Below Average
0.20
-25
-5
Average
0.50
12
6
Above Average
0.20
20
4
Boom
0.05
30
1.5
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