SOLUTION TO PROBLEMS FROM HW SET # 6

Q 1
1) PB(i)n = PB(i)n-1 ( 1 + i) + Cn ; ANB = ANB = | PB
n 0
n (i) | , where Q is the

Discounted Payback Period

A:
n PB(i)n

0 - 10,000
1 -10000(1+0.1) = -11,000
2 -11000(1.1) = -12100
3 -12100 (1.1) + 19650 = 6340

ANB = 10000+11000+12100 = 33100.

B:
n PB(i)n

0 - 10,000
1 -10000(1+0.1) + 5937 = -5063
2 -5063(1.1) + 5937 = 367.70
3 367.7 (1.1) + 5937 = 6341.47

ANB = 10000 + 5063 = 15063.

C:
n PB(i)n

0 - 10,000
1 -10000(1+0.1) + 6873 = -4127
2 -4127(1.1) + 5873 = 1333.30
3 1333.30 (1.1) + 4873 = 6339.63

ANB = 10000 + 4127= 14127

D:
n PB(i)n

0 - 10,000
1 -10000(1+0.1) + 5000 = -6000
2 -6000(1.1) + 6000 = -600
3 -600 (1.1) + 7000 = 6340

ANB = 10000+6000+600 = 16600.

(ii) Select C , because it has the smallest ANB, even though the FW are all
approximately the same.

N
3) AUR = EGCL(ANB)
n 0
n ; EGCL(ANB)n = E(ANB)n + * SD(ANB)n

AUR
G = (C0 = Numerical value of initial investment)
C0
A: AUR = (100+ 0.5 * 50)+ (100 + 0.5 * 20) + 100 = 335.

G = 335/100 = 3.35.

B: AUR = (80+ 0.5 * 40)+ (80 + 0.5 * 10) + 80 = 265.

G = 265/110 = 2.4091.

C: AUR = (150+ 0.5 * 30)+ (150 + 0.5 * 10) + 150 = 470.

G = 470/120 = 3.9167.

Select B, since it has the smallest G.

4)
A:

Seq. Cash flows NPV Prob.

1 -1000 200 1200 -1000+200/1.1

+ 1200 / 1.12 = 173.55 0.12
2 -1000 200 1600 504.13 0.18
3 -1000 -400 1600 -41.32 0.35
4 -1000 -400 2500 702.48 0.35

NPV P(NPV)
- 41.32 0.35
173.55 0.12
504.13 0.18
702.48 0.35
E(NPV)A = (- 41.32)* 0.35 + 173.55 * 0.12 + 504.13 * 0.18 + 702.48 * 0.35 = 342.98.
Var(NPV)A = (41.322) * 0.35 + 173.552 * 0.12 + 504.132* 0.18 + 702.482 * 0.35 -
342.982 = 105040.47.
SD(NPV)A = 324.10.

V = E(NPV) k SD(NPV);

VA = 342.98 2 * 324.10 = -305.22.

 Q 1
PB(i)n = PB(i)n-1 ( 1 + i) + Cn ; ANB = ANB = | PB
n 0
n (i) | , where Q is the Discounted

Payback Period
Project Balance

Seq. n=0 n=1 n=2 ANB Prob.

1 -1000 -900 210 1900 0.12
2 -1000 -900 610 1900 0.18
3 -1000 -1500 -50 2550 0.35
4 -1000 -1500 850 2500 0.35

n = 0:
E(ANB)0 = 1900 * 0.30 + 2550 * 0.35 + 2500 * 0.35 = 2337.50.
Var(ANB)0 = 19002 * 0.30 + 25502* 0.35 + 25002 * 0.35 - 2337.502 = 82,468.75.
SD(ANB)0 = 287.17;

EGCL(ANB)n = E(ANB)n + * SD(ANB)n

EGCL (ANB)0 = 2337.50 + 2 * 287.17. = 2911.84.

n=1:
E(ANB)1,1 = 1900 * 0.40 + 1900* 0.60 =1900;
E(ANB)1,2 = 2550* 0.50 + 2500* 0.50 =2525.
E(ANB)1 = 1900 * 0.30 + 2525 * 0.7 = 2337.50.
Var(ANB)1,1 = 0; Var(ANB)1,2 = 25502* 0.50 + 25002 * 0.5 - 25252 = 625.
Var(ANB)1 = 0 *0.3 + 625 * 0.7 = 437.50; SD(ANB)1 = 20.92.
EGCL (ANB)1 = 2337.50 + 2 * 20.92 = 2379.34.

n =2:
E(ANB)2 = 2337.50; Var(ANB)2 = 0; EGCL (ANB)2 = 2337.50.

N
AUR = EGCL(ANB)
n 0
n

AURA = 2911.84 + 2379.34 + 2337.50 = 7628.68.

AUR
G = ; GA = 7628.68 / 1000 = 7.6287
C0
V
Z = ; ZA = -305.22 / 7.6287 = - 40.0094.
G

B::

Seq. Cash flows NPV Prob.

1 -2000 -500 2600 -2000+500/1.1

+ 2600 / 1.12 = -305.79 0.16
2 -2000 -500 3200 190.08 0.04
3 -2000 200 2500 247.93 0.40
4 -2000 200 2500 247.93 0.40

NPV P(NPV)
- 305.79 0.16
190.08 0.04
247.93 0.80

E(NPV)A = (- 305.79)* 0.16 + 190.08 * 0.04 + 247.93 * 0.8 = 157.02.

Var(NPV)A = (305.792) * 0.16 + 190.082 * 0.04+ 247.932 * 0.8 - 157.022 = 40926.57.
SD(NPV)A = 202.30.
VA = 157.02 2 * 202.3 = -247.58

Project Balance

Seq. n=0 n=1 n=2 ANB Prob.

1 -2000 -2700 -370 5070 0.16
2 -2000 -2700 230 4700 0.04
3 -2000 -2000 300 4000 0.40
4 -2000 -2000 300 4000 0.40

n = 0:
E(ANB)0 = 5070 * 0.16+ 4700 * 0.04 + 4000 * 0.8 = 4199.20
Var(ANB)0 = 50702 * 0.16+ 47002 * 0.04 + 40002 * 0.8 - 4199.202 = 163,103.36.
.
SD(ANB)0 = 403.86; EGCL (ANB)0 = 4199.20 + 2 * 403.86 = 5006.92.

n=1:
E(ANB)1,1 = 5070 * 0.80 + 4700* 0.20 =4996;
E(ANB)1,2 = 4000* 0.50 + 4000* 0.50 =4000.
E(ANB)1 = 4199.20
Var(ANB)1,2 = 0; Var(ANB)1,1 = 50702* 0.80 + 47002 * 0.2 - 49962 = 21,904.
Var(ANB)1 = 0 *0.8 + 21904 * 0.2 = 4380.8; SD(NPV)1 = 66.19.
EGCL (ANB)1 = 4199.2 + 2 * 66.19 = 4331.58.

n =2:
E(ANB)2 = 4199.20; Var(ANB)2 = 0; EGCL (ANB)2 = 4199.20.

AURA = 5006.92 + 4331.58 + 4199.20 = 13,537.70.

GA = 13537.7 / 2000 = 6.7689

ZA = -247.58 / 6.7689 = - 36.5761.

Select B, since it has the largest Z value.