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The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,500 and has an expected life of 3 years. Annual project cash

The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,500 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability distributions:

Project A Project B
Probability Cash Flows Probability Cash Flows
0.2 $5,750 0.2 $0
0.6 $6,500 0.6 $6,500
0.2 $7,250 0.2 $19,000

BPC has decided to evaluate the riskier project at 11% and the less-risky project at 9%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

  1. What is each project's expected annual cash flow? Round your answers to two decimal places.

    Project A: $

    Project B: $

    Project B's standard deviation (B) is $6,185.47 and its coefficient of variation (CVB) is 0.80. What are the values of (A) and (CVA)? Round your answers to two decimal places.

    A = $

    CVA =

  2. Based on the risk-adjusted NPVs, which project should BPC choose?

    _________Project A // Project B

  3. If you knew that Project B's cash flows were negatively correlated with the firm's other cash flow, but Project A's cash flows were positively correlated, how might this affect the decision?

    _________ This would make Project B more appealing // This would make Project B less appealing.

  4. If Project B's cash flows were negatively correlated with gross domestic product (GDP), while A's cash flows were positively correlated, would that influence your risk assessment?

    _________This would make Project B more appealing. // This would make Project B less appealing.

image text in transcribed

image text in transcribed

A B D Project risk analysis Costs, Projects A and B Expected life of projects in years) Difference between Project A CFS $6,500.00 3 $750.00 Project A Probability 0.2 0.6 0.2 Cash Flows $5,750.00 $6,500.00 $7,250.00 1 2 B Project B 4 5 Probability 0.2 0.6 0.2 Cash Flows $0.00 $6,500.00 $19,000.00 6 3 Discount rate, risky project Discount rate, less risky project 11.00% 9.00% 1 Formulas 2 Calculation of Expected CF, SD and CV: 3 Project A 4 Expected annual cash flow 5 Standard deviation (SDA) 5 Coefficient of variation (CVA) #N/A #N/A #N/A #N/A 3 Project B: Expected annual cash flow Standard deviation (SD) 1 Coefficient of variation (CV) $9,876.74 #DIV/0! 2 3 Which project is riskier? 4 Project A risk-adjusted discount rate 5 Project B risk-adjusted discount rate #N/A #N/A #N/A Calculation of Risk-Adjusted NPVS: NPVA NPVE Which project should be chosen? #N/A #N/A #N/A

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