SOLUTIONS TO PROBLEMS FROM HW SET 7

1) A:
N P(N) NPV
1.14 1
4 0.2 -10000+3000 4
= -490.40
0.1(1.1)
1.15 1
5 0.4 -10000+3000 5
= 1372.40
0.1(1.1)
1.16 1
6 0.4 -10000+3000 6
= 3065.80
0.1(1.1)
E(NPV) = (-490.4)*0.2+(1372.4)*0.4+(3065.8)*0.4 = $ 1677.20.
Var(NPV) = (-490.4)2*0.2+(1372.42)*0.4+(3065.82)*0.4 - 1677.202 = 1,748,100.
SD(NPV) = $ 1322.16.
B:
N P(N) NPV
1.13 1
3 0.1 -10000+3000 3
= -2539.40
0.1(1.1)
1.14 1
4 0.2 -10000+3000 4
= -490.40
0.1(1.1)
1.15 1
5 0.3 -10000+3000 5
= 1372.40
0.1(1.1)
1.16 1
6 0.2 -10000+3000 6
= 3065.80
0.1(1.1)
1.17 1
7 0.2 -10000+3000 7
= 4605.30
0.1(1.1)
E(NPV) =(-2539.4)*0.1+ (-490.4)*0.2+(1372.4)*0.3+(3065.8)*0.2+(4605.3)*0.2
= $ 1593.92.
Var(NPV) =(-2539.4)2 *0.1+ (-490.4)2*0.2+(1372.42)*0.3+(3065.82)*0.2+(4605.32)*0.2
- 1593.922 = 4,839,000.
SD(NPV) = $ 2199.80.

Project A is recommended, because it has a larger E(NPV) and smaller SD (NPV),

compared to B.

2) A:
N P(N) NPV
1.13 1
3 0.1 -100,000+30,000 3
= -25394.44
0.1(1.1)
 1.14 1
4 0.4 -100,000+30,000 4
= -4904.04
0.1(1.1)
1.15 1
5 0.5 -100,000+30,000 5
= 13723.60.
0.1(1.1)
E(NPV) = (-25394.44)*0.1+(-4904.04)*0.4+(13723.60)*0.5 = $ 2360.74.
Var(NPV) = (-25394.442)*0.1+(-4904.042)*0.4+(13723.602)*0.5 2360.742 =
162,703,107.
SD(NPV) = $ 12755.51.

B:
N P(N) NPV
1.13 1
3 0.2 -100,000+30,000 3
= -25394.44
0.1(1.1)
1.14 1
4 0.3 -100,000+30,000 4
= -4904.04
0.1(1.1)
1.15 1
5 0.3 -100,000+30,000 5
= 13723.60
0.1(1.1)
1.16 1
6 0.2 -100,000+30,000 6
= 30657.82
0.1(1.1)
E(NPV) = (-25394.44)*0.2+(-4904.04)*0.3+(13723.60)*0.3+ (30657.82)*0.2 =
$ 3698.54.
Var(NPV) = (-25394.442)*0.2+(-4904.042)*0.3+(13723.602)*0.3+ +(30657.822)*0.2
3698.542 = 366,992,716.
SD(NPV) = $ 19,157.05.

Project A has a smaller E(NPV) and smaller SD(NPV) compared to B. Additional criteria
such as P[NPV < Aspiration Level] is required to select the best project.

3) A
n E(Cn) Var(Cn) E(Xn) Var(Cn) P(N=n)
0 -10000 0 -10000 0 0
1 10000 40000 9090.91 33057.85 0.3
2 10000 90000 8264.46 61471.21 0.4
3 10000 160000 7513.15 90315.83 0.3

E(NPV) = (-10000+9090.91)*0.3 + (-10000+9090.91+8264.46)*0.4+

(-10000+9090.91+8264.46+7513.15)*0.3 = $ 7130.00.

Var(NPV) = 0.3 *[33057.85+(-10000+9090.91)2]

+
0.4* [33057.85+61471.21+(-10000+9090.91+8264.46)2]
+
 0.3*[33057.85+61471.21+90315.83+(-10000+9090.91+8264.46+7513.15)2]

- 71302 = 37,477,000.
SD(NPV) = $ 6121.80.

B.
n E(Cn) Var(Cn) E(Xn) Var(Xn) P(N=n)
0 -15000 0 -15000 0 0
1 12000 60000 10909.09 49586.78 0.3
2 15000 75000 12396.69 51226.01 0.5
3 30000 100000 22539.44 56447.39 0.2

E(NPV) = (-15000+10909.09)*0.3 + (-15000+10909.09+12396.69)*0.5

+ (-15000+10909.09+12396.69+22539.44)*0.2 = $ 9094.70.

Var(NPV) = 0.3 * [ 49586.78+(-15000+10909.09)2]

+
0.5 * [ 49586.78+51226.01+(-15000+10909.09+12396.69)2]
+
0.3* [ 49586.78+51226.01+56447.39+(-15000+10909.09+12396.69+22539.44)2]

- 9094.702 = 147,180,000.

SD(NPV) = $ 12,132.

Project A has a smaller E(NPV) and smaller SD(NPV) compared to B. Additional criteria
such as P[NPV < Aspiration Level] is required to select the best project.

4) A
n E(Cn) Var(Cn) E(Xn) Var(Cn) P(N=n)
0 -25000 0 -25000 0 0
1 15000 62500 13636.36 51652.89 0.1
2 15000 90000 12396.69 61471.21 0.4
3 15000 122500 11269.72 69148.06 0.5

E(NPV) = (-25000+13636.36)*0.1 + (-25000+13636.36+12396.69)*0.4+

(-25000+13636.36+12396.69+ 11269.72)*0.5= $ 5428.24

Var(NPV) = 0.1 *[51652.89+(-25000+13636.36)2]

+
0.4* [51652.89+61471.21+(-25000+13636.36+12396.69)2]
+
0.5*[51652.89+61471.21+ 69148.06 +(-25000+13636.36+12396.69+11269.72)2]

- 5428.242 = 59,694,945.
SD(NPV) = $ 7726.25.
B.
n E(Cn) Var(Cn) E(Xn) Var(Xn) P(N=n)
0 -30000 0 -30000 0 0
1 10000 60000 9090.91 49586.78 0.2
2 15000 75000 12396.69 51226.01 0.3
3 30000 100000 22539.44 56447.39 0.5

E(NPV) = (-30000+9090.91)*0.2 + (-30000+9090.91+12396.69)*0.3

+ (-30000+9090.91+12396.69+22539.44)*0.5
= $ 277.98.

Var(NPV) = 0.2 * [ 49586.78+(-30000+9090.91)2]

+
0.5 * [ 49586.78+51226.01+(-30000+9090.91+12396.69)2]
+
0.3* [ 49586.78+51226.01+56447.39+(-30000+9090.91+12396.69+22539.44)2]

- 277.982 = 231,290,336.

SD(NPV) = $ 15208.23.

Project A has a larger E(NPV) and smaller SD(NPV) compared to and hence select A.