Trial Guides, Inc., is currently evaluating two mutually exclusive investments. After doing a scenario analysis and applying probabilities to each scenario, they have determined that the investments have the following distributions around the expected NPVs.
Probability NPVa NPVb
15% -$40,000 $-15,000
20% -$10,000 $2,500
30% $20,000 $20,000
20% $50,000 $37,500
15% $80,000 $55,000
Several members of the management team have suggested that Project A should be selected because it has a higher potential NPV. Other members have suggested that Project B appears to be more conservative and should be selected. They have asked you to resolve this question.
a) Calculate the expected NPV for both projects. Can the question be resolved with this information alone?
b) Calculate the variance and standard deviation of the NPVs for both projects. Which project appears to be riskier?
c) Calculate the coefficient of variation for both projects. Does this change your opinion from part b?
d) Calculate the probability of a negative NPV for both projects.
e) Which project should be accepted?