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Risk-adjusted NPV of 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 distribution:

Project A Project B
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Probability Net Cash Flow Probabilty Net Cash Flow
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0.2 $6,000 0.2 $0
0.6 6,750 0.6 $6,750
0.2 7.500 0.2 18,000

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

a. What is the expected value for the annual net cash flows from each project? What is the coefficient of variation?

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 would that influence your assessment of its risk?

Solution Summary

Risk-adjusted NPV of two mutually exclusive Projects are calculated

$2.19