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

For a project, the expected NPV is Rs 40,000 and the standard deviation of NPV is Rs 20,000. Assuming NPV is normally distributed, what is the approximate probability that the project's NPV is negative? (Area from mean to Z = 2 is 0.4772.)

The probability of a negative NPV is about 2.28%. The cutoff of zero lies two standard deviations below the mean of 40,000, since the standard deviation is 20,000. The one-sided tail beyond Z of 2 is 0.5 minus 0.4772, which equals 0.0228.

  1. A4.56%
  2. B2.28%Correct
  3. C47.72%
  4. D5.00%

Explanation

Z = (0 - 40,000)/20,000 = -2. Area from the mean to Z=2 is 0.4772, so the tail beyond is 0.5 - 0.4772 = 0.0228. The probability of a negative NPV is 2.28%. The 4.56% option wrongly doubles the tail by using both sides.

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