problem: A firm's cost of capital is nine percent each year & it is considering two mutually exclusive, standalone investments. The projects each cost dollar 10,000 & the company has exactly this amount to invest. Project Alpha has a standard deviation of 4.5 percent [the same as the firm's typical project and Project Gamma has a standard deviation of 8 percent, which requires an additional three percent risk add on to the base discount rate. The firm must invest in one of these projects. Which one should it select? Describe clearly the quantitative reason[S] for your conclusion.
|
Project
|
Cost ($)
|
Cash flow1 ($)
|
Cash flow2 ($)
|
Cash flow3 ($)
|
|
Alpha
|
$10,000
|
$2,000
|
$5,000
|
$7,000
|
|
Gamma
|
$10,000
|
$6,000
|
$7,000
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$3,000
|