Nov 26, 2020 in Coursework

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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

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The expected value combines the 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 a higher expected value than project B; therefore, it offers a better decision alternative for choosing between the two projects.

Question 2 Coefficient of Variation

The 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

The standard deviation for project A = $1205.543

Standard deviation for project B = $8003.333

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Therefore,

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

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

The coefficient of variation presents information about the relative measure of risk associated with each project. In this case, project B is considered riskier 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.

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Question 3 Riskiness of the Project

Project B is riskier 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

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According to Hirschey (2009), one should choose a project with a higher positive 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 riskier than project A. Hence, the company should choose to 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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