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

Kaveri Engineering is comparing two mutually exclusive projects. Project X has an expected NPV of ₹6,00,000 and a standard deviation of ₹1,50,000. Project Y has an expected NPV of ₹9,00,000 and a standard deviation of ₹2,70,000. Using the coefficient of variation as the risk-per-unit-of-return measure, which statement is correct?

Project X is preferred. Its coefficient of variation is 0.25 (1,50,000 divided by 6,00,000), lower than Y's 0.30 (2,70,000 divided by 9,00,000). A lower coefficient of variation means less risk for each rupee of expected NPV.

  1. AX is preferred, with CV of 0.25 against 0.30 for YCorrect
  2. BY is preferred, with CV of 0.30 against 0.25 for X
  3. CX is preferred, with CV of 4.00 against 3.33 for Y
  4. DY is preferred, because its expected NPV and standard deviation are both higher

Explanation

CV = standard deviation / expected NPV. For X it is 1,50,000 / 6,00,000 = 0.25, and for Y it is 2,70,000 / 9,00,000 = 0.30. A lower CV means less risk per rupee of expected return, so X is preferred. The option with 4.00 and 3.33 uses the inverse ratio, and the last option ignores relative risk.

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