# How to measure risk between two investment projects

1. Two investments have the following expected returns (net present values) and standard deviation of returns:

Project Expected Returns Standard Deviation

A $50,000 $40,000

B $250,000 $125,000

Which one is riskier? Why?

2. The manager of the Aerospace division of General Aeronautics has estimated the price can change for providing satellite launch services to commercial firms. Her most optimistic estimate (a price not expected to be exceeded more than 10 percent of the time) is $2 million. Her most pessimistic estimate (a lower price than this one is not expected more than 10 percent of the time) is $1 million. The expected value estimate is $1.5 million. The price distribution is believed to be approximately normal.

a. What is the expected price?

b. What is the standard deviation of the launch price?

c. What is the probability of receiving a price less than 1.2 million?

https://brainmass.com/economics/investments/how-to-measure-risk-between-two-investment-projects-507398

#### Solution Preview

Problem 1: In order to answer this question,you have to remember that another way of expressing risk is the standard deviation.The standard deviation measures risk.So to re-state this question:Which project has the highest standard deviation?

Problem 2:

a) The expected price is the mean.How do you calculate the mean?Here we are given 2 estimates;$2 million and $1 million.Write down whatever is given,it will make your life easier.Once you have read the problem carefully,try to isolate what you neeed for your ...

#### Solution Summary

The answer is an explanation of how to use basic statistical concepts in order to measure risk when deciding between two or more investment projects.

Here you will find an explanation of the computation of the expected value,the z value and the standard deviation.

The solution is original therefore does not include any references.

Compute free cash flow, initial outlay, terminal cash flow, NPV, IRR. Discuss project risk, CAPM, simulations and sensitivity analysis.

Using data in the attached excel file, respond to these:

Should the company focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows,

incremental profits, total free cash flows, or total profits?

b.

How does depreciation affect free cash flows?

c.

How do sunk costs affect the determination of cash flows?

d.

What is the projects initial outlay?

e.

What are the differential cash flows over the projects life?

f.

What is the terminal cash flow?

g.

Draw a cash flow diagram for this project?

h.

What is its net present value?

i.

What is its internal rate of return?

j.

Should the project be accepted? Why or why not?

k.

In capital budgeting, risk can be measured from three perspectives. What are those three measures of a projects risk?

l.

According to CAPM, which measurements of a projects risk is relevant? What complications does reality introduce into the CAPM view of risk, and what does that

mean for our view of the relevant measure of a projects risk?

m.

Explain how simulation works. What is the value in using a simulation approach?

n.

What is sensitivity analysis and what is its purpose?