The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each costs $6,750 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:

BPC has decided to evaluate the riskier project at 12% and the less risky project at 10%.

a. What is each project’s expected annual cash flow? Project B’s standard deviation (σ_B) is $5,798, and its coefficient of variation (CV_B) is 0.76. What are the values of σ_A and CV_A?

b. Based on the risk-adjusted NPVs, which project should BPC choose?

c. If you knew that Project B’s cash flows were negatively correlated with the firm’s other cash flows whereas Project A’s flows were positively correlated, how might this affect the decision? If Project B’s cash flows were negatively correlated with gross domestic product (GDP) while A’s flows were positively correlated, would that influence your risk assessment? Explain.

PROJECT A Probability 0.2 0.6 0.2 PROJECT B Cash Flows Cash Flows Probability 0.2 0.6 0.2 $6,000 6,750 6,750 18,000 7,500