Question

e cost of capital and From a purely bital budget under project cost of capital? 15.7 What is meant by the term capital rationing? From a financial standpoint, what is the optimal capital budge capital rationing? 15.8 Santa Roberta Clinic has estimated its corporate cost of be 11 percent. What are reasonable values for the pro capital for low-risk, average-risk, and high-risk projects 15.9 Under what conditions should a business estimate divisie ost of capital to woject CONS capital? divisional cos 15.10 Describe the qualitative approach to risk assessment. Whu approach, which does not rely on numerical data, work Why does this Problems 15.1 The managers of Merton Medical Clinic are analyzing a prop project. The project's most likely NPV is $120,000, but as evidenced by the following NPV distribution, there is consider risk involved: Probability 0.05 0.20 0.50 0.20 0.05 NPV ($700,000) (250,000) 120,000 200,000 300,000 a. What are the project's expected NPV and standard deviation of NPV? b. Should the base case analysis use the most likely NPV or the expected NPV? Explain your answer. 2 TTT

Answer 1

a)

Expected NPV = 30,000

Standard Deviation = 236220.24

Please find the below table for further Calculation

Probability	NPV	Probability * NPV	NPV - Expected NPV	(NPV - Expected NPV)^2	(NPV - Expected NPV)^2 * Probability
0.05	-700000	-35000	-730000	5.329E+11	26645000000
0.2	-250000	-50000	-280000	78400000000	15680000000
0.5	120000	60000	90000	8100000000	4050000000
0.2	200000	40000	170000	28900000000	5780000000
0.05	300000	15000	270000	72900000000	3645000000
Expected NPV		30000
Total					55800000000
Standard Deviation					236220.2362

b) Base case analysis should use Expected NPV as here we have identified all the possibility probabilities of inflows and expected NPV is based on that. In expected NPV we have also considered probability of negative flows which is ignored in most likely NPV.

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