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CMA Final · Strategic Financial Management · Evaluation of Risky Proposals for Investment Decisions

A project of Kaveri Engineering has an initial outlay of Rs 1,00,000 and a single cash inflow at the end of year 1 with the following probability distribution: Rs 80,000 (probability 0.2), Rs 1,20,000 (probability 0.5), Rs 1,60,000 (probability 0.3). The discount rate is 10%. What is the standard deviation of the year 1 cash flow?

The expected cash flow is Rs 1,24,000. Squared deviations weighted by probability give a variance of 784 million, so the standard deviation is Rs 28,000. Discounting is not needed for the standard deviation of the undiscounted year 1 cash flow.

  1. ARs 28,000 (approximately)
  2. BRs 31,368 (approximately)Correct
  3. CRs 40,000
  4. DRs 9,84,000

Explanation

Mean = 16,000 + 60,000 + 48,000 = 1,24,000. Deviations: -44,000, -4,000, +36,000. Variance = 0.2x1,936,000,000/1000... computing: 0.2x1,936 + 0.5x16 + 0.3x1,296 (in lakhs of thousand-squared units) = 387.2 + 8 + 388.8 = 784 (in 10^6), so variance = 784 million and SD = 28,000. So the correct SD is Rs 28,000.

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