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140 Financial Management
Cash inflows Year Rs. Probability Rs. Probability
1 10,000 .2 12,000 .2
2 18,000 .6 16,000 .6
3 8,000 .2 14,000 .2
Assuming cost of capital at (or) advise the selection of the project:
Solution
Calculation of net project values of the two projects.
Project A
Year P.V. Factor Cash Probability Monetary Present
@ 10 % Inflow Value Value Rs.
1 0.909 10,000 .2 2,000 1,818
2 0.826 18,000 .6 10,800 8,921
3 0.751 8,000 .2 1,600 1,202
Total Present value 11,941
Cost of Investment 10,000
Net present value 1,941
Project B
Year P.V. Factor Cash Probability Monetary Present
@ 10 % Inflow Value Value Rs.
1 0.909 12,000 .2 2,400 2,182
2 0.826 14,000 .6 8,400 6,938
3 0.751 14,000 .2 2,800 2,103
Total present value 11,223
Cost of investment 10,000
Net present value 1,223
As net present value of project A is more than that of project B after taking into
consideration the probabilities of cash inflows project A is more profitable one.
(v) Standard deviation method
Two Projects have the same cash outflow and their net values are also the same,
standard durations of the expected cash inflows of the two Projects may be
calculated to measure the comparative and risk of the Projects. The project having
a higher standard deviation in said to be more risky as compared to the other.
Exercise 17
From the following information, ascertain which project should be selected on the
basis of standard deviation.