A business executive is trying to decide whether to undertake one of two contrac
ID: 2789093 • Letter: A
Question
A business executive is trying to decide whether to undertake one of two contracts or neither one. He has simplified the situation somewhat and feels that it is sufficient to imagine that the contracts provide alternatives as given in the table below. Assume that both contracts are statistically independent from each other Click the icon to view the additional data for the projects (a) Should the executive undertake either one of the contracts? If so, which one? What would he do if he made decisions with an eye toward maximizing his expected NPW? The expected value of NPW of Project 1 is S 33500. (Round to the nearest dollar.) The expected value of NPW of Project 2 is $ 31500. (Round to the nearest dollar.) The variance of NPW of Project 1 is 2473 million dollars squared. (Round to the nearest whole number.) The variance of NPW of Project 2 is 455 million dollars squared. (Round to the nearest whole number.) Which project would you select considering the expected value of NPW and its variance? Choose the correct answer below A. It is not a clear case B. Project 2 O C. Project 1 (b) What would be the probability that contract A would result in a larger profit than that of contract B? The probability that contract A would result in a larger profit than that of contract B is1. (Round to two decimal places.) More Info Contract A Contract B NPW $110,000 70,000 - 20,000 Probability 0.10 0.45 0.45 NPW 60,000 30,000 5,000 Probability 0.30 0.40 0.30Explanation / Answer
Standard deviation of project 2 = square root of 455 i.e 21.33
Coefficient of variation of project 1 =49.73/33500 =0.0012(rounded off to 4 decimals)
Coefficient of variation of project 2 = 21.33/31500 =0.00068(rounded off to 5 decimals)
Since coefficient of variation is lower in case of project 2,project 2 should be selected.
In the given case,there is .45 probability that the cash flows wil be negative in contract A.
and there is 0.55(0.1 + 0.45) probability that cash flows of contract A(i.e 70000,110000) will be morethan the highest probable cash flow from contract b(i.e 60000).
so the probabilty that contract A may result in larger profit than that of contract B is 0.55.
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