Chapter 14 Risk and Managerial Options in Capital Budgeting 14-1
14-1 Chapter 14 Risk and Managerial Options in Capital Budgeting
Risk and Managerial Options in Capital a The Problem of Project Risk o Total Project Risk a Contribution to Total firm risk Firm-Portfolio Approach a Managerial Options 14-2
14-2 Risk and Managerial Options in Capital Budgeting The Problem of Project Risk Total Project Risk Contribution to Total Firm Risk: Firm-Portfolio Approach Managerial Options
An llustration of total risk Discrete Distribution) ANNUAL CASH FLOWS: YEAR 1 PROPOSALA State Probability Cash Flow Deep Recession 05 $-3,000 Mild recession 25 1,000 Normal 40 5,000 Minor boom 25 9,000 Major Boom 05 13,000
14-3 An Illustration of Total Risk (Discrete Distribution) ANNUAL CASH FLOWS: YEAR 1 PROPOSAL A State Probability Cash Flow Deep Recession .05 $ -3,000 Mild Recession .25 1,000 Normal .40 5,000 Minor Boom .25 9,000 Major Boom .05 13,000
Probability Distribution of year 1 Cash Flows Proposal A 40 25 05 -3,0001,0005,0009,00013,000 Cash Flow() 14-4
14-4 Probability Distribution of Year 1 Cash Flows .40 .05 .25 Probability -3,000 1,000 5,000 9,000 13,000 Cash Flow ($) Proposal A
Expected Value of Year 1 Cash Flows(Proposal CF1 P (cF1)() $-3,000 05 $-150 1,000 25 250 5.000 40 2.000 9.000 25 2,250 13,000 05 650 ∑=1.00CF1=$5,000 14-5
14-5 CF1 P1 (CF1 )(P1 ) $ -3,000 .05 $ -150 1,000 .25 250 5,000 .40 2,000 9,000 .25 2,250 13,000 .05 650 =1.00 CF1=$5,000 Expected Value of Year 1 Cash Flows (Proposal A)