11-15 The Butler-Perkins Company (BPC) must decide between two mutually exclusiv
ID: 2766800 • Letter: 1
Question
11-15 The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,750 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment is made and have the following probability distributions:
Project A
Project B
Probability
Cash Flows
Probability
Cash Flows
0.2
$6,500
0.2
$0
0.6
$6,750
0.6
$6,750
0.2
$7,500
0.2
$18,000
BBC has decided to evaluate the riskier project at 12% rate and the less risky project at a 10% rate.
A. What is the expected value of the annual net cash flows from each project? What is a coefficient of variation CV?
B. What is the risk-adjusted NPV of each project?
C. 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 that decision? If project B's cash flows were negatively correlated with gross domestic product GDP, would that influence your assessment of its risk?
PLEASE SHOW WORK
Project A
Project B
Probability
Cash Flows
Probability
Cash Flows
0.2
$6,500
0.2
$0
0.6
$6,750
0.6
$6,750
0.2
$7,500
0.2
$18,000
Explanation / Answer
A. Expected net cash flows from each project
Project A: 6500 *0.2 + 6750*0.6 + 7500*0.2 = $6,850
Project B : 0.2*0+0.6*6750+0.2*18000 = $7,650
The coefficient of variation for project A is calulated as follows:
The coefficient of variation for project B is calulated as follows:
B. NPV of project A at 10% (less risky)
The NPV of project B is as follows:
C: If the all the projecs of the firms are not performing upto the mark, the selecting B makes sense becuase of negative correlation
If the GDP of the country is reducing and the economy of the country is in recession, then selecting B makes sense becuase of the negative correlation
Project A 0.2 6500 0.6 6750 0.2 7500 Coeffient of variance 0.075241Related Questions
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