Question

The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $7,000 and has an expected life of 3 years. Annual project cash flows begin 1 year after the initial investment and are subject to the following probability distributions:
Project A Project B
Probability Cash Flows Probability Cash Flows
0.2 $6,250 0.2 $0
0.6 $7,000 0.6 $7,000
0.2 $7,750 0.2 $17,000
BPC has decided to evaluate the riskier project at 13% and the less-risky project at 10%.
a. What is each project's expected annual cash flow? Round your answers to two decimal places.
b. Based on the risk-adjusted NPVs, which project should BPC choose?

Answer 1

Answer:

a. The project A's expected annual cash flow is $7,000

The project B's expected annual cash flow is $7,600

b. BPC should choose the project b

Explanation:

a. In order to calcualte the project A's expected annual cash flow we would have to make the following calculation:

project A's expected annual cash flow =0.2*$6,250 +0.6 *$7,000+0.2 *$7,750=$7,000

In order to calcualte the project B's expected annual cash flow we would have to make the following calculation:

project B's expected annual cash flow =0.2*$0 +0.6 *$7,000+0.2 *$17,000 =$7,600

b. Becuase Project B's CV is higher , hence Project B has the higher NPV, thus, the firm should accept Project B.