Scenario Analysis Shao Industries is considering a proposed project for its capi

Question

Scenario Analysis Shao Industries is considering a proposed project for its capital budget. The company estimates the project's NPV is $12 million. This estimate assumes that the economy and market conditions will be average over the next few years. The company's CFO, however, forecasts there is only a 50% chance that the economy will be average. Recognizing this uncertainty, she has also performed the following scenario analysis: Economic Scenario Probability of Outcome NPV Recession 0.05 -$70 million Below average 0.20 -22 million Average 0.50 12 million Above average 0.20 20 million Boom 0.05 30 million What is the project's expected NPV, its standard deviation, and its coefficient of variation? Enter your answers for the NPV and standard deviation in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places. E(NPV) ______ million NPV $ _______ million CVNPV ______

Explanation / Answer

The expected NPV is

E(NPV) = 0.05*(-70) + 0.20*(-22) + 0.50*12 + 0.20*20 + 0.05*30

   = 3.6

variance = 0.05*(-70-3.6)2 + 0.20*(-22-3.6)2 + 0.50*(12-3.6)2 + 0.20*(20-3.6)2 + 0.05*(30-3.6)2 = 525.84

Standard deviation = sqrt(variance)

= sqrt(525.84) = 22.93

Coefiicient of variation = Standard deviation / expected NPV

= 22.93 / 3.6 = 6.37

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