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

A project of Kaveri Industries has the following possible Year 1 cash inflows: Rs 2,00,000 with probability 0.3, Rs 4,00,000 with probability 0.5 and Rs 6,00,000 with probability 0.2. What is the standard deviation of the Year 1 cash inflow?

The standard deviation is about Rs 1,40,000. The expected inflow is Rs 3.8 lakh, the probability-weighted squared deviations total 1.96 lakh squared, and the square root of that is 1.4 lakh.

  1. ARs 1,40,000 approx
  2. BRs 2,00,000 approx
  3. CRs 1,95,959 approxCorrect
  4. DRs 3,84,000 approx

Explanation

Mean = 0.3x2 + 0.5x4 + 0.2x6 = 0.6+2.0+1.2 = Rs 3.8 lakh. Variance = 0.3(1.8)^2 + 0.5(0.2)^2 + 0.2(2.2)^2 = 0.972+0.02+0.968 = 1.96 (lakh squared). SD = 1.4 lakh = Rs 1,40,000. The option Rs 1,95,959 uses the wrong root of variance in rupees mix; correct is Rs 1,40,000.

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