THE BARTRAM-PULLEY COMPANY (BPC) MUST DECIDE BETWEEN TWO MUTUALLY EXCLUSIVE INVESTMENT PROJECTS.

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions:

 

Project A

 

Project B

 

Probability Net Cash Flows

 

Probability Net Cash Flows
0.2$6,000 $6,000 0.2 $ 0
0.6 6750 0.6 6,750
0.27,500 7,500 0.2 18,000

 

BPC has decided to evaluate the riskier project at a 12 percent rate and the less risky project at a 10 percent rate.

a. What is the expected value of the annual net cash flows from each project? What is the coefficient of variation (CV)? (Hint: sB = $5,798 and CV B 0.76.)

b. What is the risk-adjusted NPV of each project?

c. If it were known that Project B was negatively correlated with other cash flows of the firm whereas Project A was positively correlated, how would this knowledge affect the decision? If Project B”s cash flows were negatively correlated with gross domestic product (GDP), would that influence your assessment of its risk?

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