What else do we need to do before making a decision under uncertainty after the expected value, standard deviation, and coefficient of variation are already calculated?
What else do we need to do before making a decision under uncertainty after the expected value, standard deviation, and coefficient of variation are already calculated?
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The San Diego LLC is considering a three-year project, Project A, involving an initial investment of $80 million and the following cash inflows and probabilities:
|
Year 0 |
Year 1 |
Year 2 |
Year 3 |
|||
|
Probability |
Cash Flow |
Probability |
Cash Flow |
Probability |
Cash Flow |
|
|
0.2 |
50 |
0.1 |
60 |
0.3 |
70 |
|
|
0.3 |
40 |
0.2 |
50 |
0.4 |
60 |
|
|
0.4 |
30 |
0.3 |
40 |
0.1 |
50 |
|
|
0.1 |
20 |
0.4 |
30 |
0.2 |
40 |
|
|
Initial Investment |
||||||
|
Discount Rate |
||||||
Describe your answer for each question in complete sentences, whenever it is necessary.
a. Describe and calculate Project A's expected net present value (ENPV) and standard deviation (SD), assuming the discount rate (or risk-free interest rate) to be 8%. What is the decision rule in terms of ENPV? What will be San Diego LLC's decision regarding this project? Describe your answer.
b. The company is also considering another three-year project, Project B, which has an ENPV of $32 million and a standard deviation of $10.5 million. Project A and B are mutually exclusive. Which of the two projects would you prefer if you do not consider the risk factor? Explain.
c. Describe the coefficient of variation (CV) and the standard deviation (SD) in connection with risk attitudes and decision making. If you now also consider your risk-aversion attitude, as the CEO of the San Diego LLC will you make a different decision between Project A and Project B? Why or why not?
