The coefficient of variation of existing projects (u/NPV) = 18,112/

46,000 = .39. The coefficient of variation for existing projects plus puddings

= 22,659/58,000 = .39. Although the pudding line has a higher coefficient of variation (9,000/12,000 = .75) than existing products, indicating a higher degree of risk, the correlation of this product line with existing lines is sufficiently low as to bring the coefficient of variation for all products including puddings in line with that for only existing products.

Cash Flow (in Millions)

INITIAL SCENARIO 1 SCENARIO 2 Time PROJECT PROBABILITY = .3 PROBABILITY = .3 1 $ 6 2 - 6 3 1 4 2 5 4 -$lo -$lo 6 4 6 4 7 3 6 4 8 1 6 4 9 6 4 10 6 4 NPV (14%) $2.57 $5.51 $1.94 C h a p t e r 7 R i s k a n d R e a l O p t i o n s in C a p i t a l B u d g e t i n g 197