The Butler-Perkins Company (BPC) must decide between twomutually exclusive proje
ID: 2770650 • Letter: T
Question
The Butler-Perkins Company (BPC) must decide between twomutually exclusive projects. Each costs $6,750 and has an expectedlife of 3 years. Annual project cash flows begin 1 year after theinitial investment, and are subject to the following probabilitydistribution:
PROJECTA PROJECT B
Probability cashFlows Probability Cash Flows
0.2 $6,000 0.2 $0
0.6 6,750 0.6 6,750
0.2 7,500 0.2 18,000
BPC has decided to evaluate the riskier project at 12 percentand the less-risky project at 10 percent.
a. What is each project’s expectedannual cash flow? Project B’s standard deviation (sB) is$5,798 and its coefficient of variation (CVb) is 0.76. what are thevalues of sA and CVa?
b. Based on their risk-adjusted NPVs, whichproject should BPC choose?
c. If you knew that Project B’scash flows were negatively correlation with the firm’s othercash flow, whereas Project A’s flows were positivelycorrelated, how might this affect the decision? If ProjectB’s cash flows were negatively correlated with gross domesticproduct (GDP), while A’s flows were positively correlated,would that influence your risk assessment?
Explanation / Answer
PROJECT A
PROJECT B
Probability
Cash Flows
Probability Cashflows
Probability
Cash Flows
Probability Cashflows
PROJECT A
PROJECT B
Probability
Cash Flows
Probability Cashflows
Probability
Cash Flows
Probability Cashflows
0.2 $6,000 $1,200 0.2 $0 $0 0.6 $6,750 $4,050 0.6 $6,750 $4,050 0.2 $7,500 $1,500 0.2 $18,000 $3,600 Expected Annual Cashflow $6,750 Expected Annual Cashflow $7,650 Co-efficient of Variation: CV = [Standard Deviation / Expected Value] =[NPV / Expected NPV]Related Questions
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