Your company asks you to analyze two mutually exclusive projects for the coming year. Project A will have an initial outlay of $7,200. Project B will cost $6,800. Both projects will last for three years.
On the basis of the information regarding the risk involved in the two projects, you come up with the following probability distributions for the projects:
Project A
Project B
Probability
Net Cash Flows ($)
Probability
Net Cash Flows ($)
0.2
8,100
0.2
500
0.5
9,100
0.5
8,100
0.3
10,500
0.3
16,500
To evaluate the two projects, you decide to use the company's weighted average cost of capital (WACC) for the less risky project (12 percent) and the WACC plus two points (14 percent) for the more risky project.
•What is the expected value for each project? What does this value represent?
•What is the coefficient of variation for each project? What information does this measure provide to you and to the company?
•Which project has the most risk? Why?
•What is the risk-adjusted NPV for each project? What do these measures tell you and the company?
•Which project would you recommend to management, and how would you justify your selection?
•If these two projects were not mutually exclusive, would you select both? Why or why not?
Create your report in a 2- to 3-page Microsoft Word document.
Calculated the expected value for each project, explained what this value represents, calculated the coefficient of variation for each project, and described what information this measure provides to you and to the company.
Analyzed and justified which project has the most risk, calculated the risk-adjusted NPV for each project, and explained what these measures tell you and the company.
Analyzed and justified which project you would recommend to management, and if these two projects were not mutually exclusive whether you would select both.