Nov 26, 2020 in Coursework

Incorporation of Risk into the Decision-Making Process

Question 1 - Expected Value for Each Project

Expected value for project A = (0.3*$8,100) + (0.5 * $9,100) + (0.2 *$10,500) = $9080

Expected value for project B = (0.3 * $500) + (0.5 * $8,100) + (0.2 * $16, 500) = $7500

The expected value combines payoffs and probabilities of each project. The above value reflects the expected value for each project. In this case, the expected value of project A is $9,080 and the expected value of project B is $7,500. Project A has higher expected value than project B; therefore, it offers a better decision alterative for choosing between the two projects.

Question 2 Coefficient of Variation

Coefficient of variation for each project is calculated by computing the standard deviation and dividing it by the expected value (Coefficient of Variation, 2013) i.e.

Coefficient of variation = Standard Deviation/ Expected Value

Standard deviation for project A = $1205.543

Standard deviation for project B = $8003.333

Therefore,

Coefficient of variation for project A =$ 1205.543/$9080 =$ 0.1328

Coefficient of variation for project B =$ 8003.333/$7500 =$ 1.0671

Coefficient of variation presents information about the relative measure of risk associated with each project. In this case, project B is considered more risky than project A. this information helps the company to know how much volatility it is assuming in relationship to the amount of return to expect from the investment.

Question 3 Riskiness of the Project

Project B is more risky than project A. This is because it has a higher coefficient of variation than project A.

Question 4 Risk Adjusted NPV

Risk adjusted NPV is calculated in excel by using this formula (=NPV {rate, value 1, value 2, value 3}

Therefore,

Risk Adjusted NPV for project A =$ 22360.57

Hence,

NPV of project A =$ 22360.57 $ 7200 = $15186.64

Risk Adjusted NPV for project B = $18221.29

NPV of project B = $18221.29 $ 6800 = $14321.1

Question 5 Recommendation

According to Hirschey (2009), one should chose a project with a higher positve NPV. Therefore, the management of the company should select Project A because it has a higher positive NPV as compared to project A. Furthermore, project B is more risky than project A. Hence, the company should choose project A.

Question 6 Mutually Exclusivity

If project A and project B were mutually exclusive, I would still select project A. This is because it has a high risk adjusted NPV.

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