(11–15)

Risky Cash Flows The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years.

Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:

462 Part 4: Projects and Their Valuation Project A Project B Probability Net Cash Flows Probability Net 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 a 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 the coefficient of variation (CV)? (Hint: σB = $5,798 and CVB = 0.76.)

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 the decision? If Project B’s cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?