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1、14-1Chapter 14Risk and Managerial Risk and Managerial Options in Capital Options in Capital BudgetingBudgeting 2001 Prentice-Hall,Inc.Fundamentals of Financial Management,11/eCreated by:Gregory A.Kuhlemeyer,Ph.D.Carroll College,Waukesha,WI14-2Risk and Managerial Risk and Managerial Options in Capita

2、l BudgetingOptions in Capital BudgetinguuThe Problem of Project RiskThe Problem of Project RiskuuTotal Project RiskTotal Project RiskuuContribution to Total Firm Risk:Contribution to Total Firm Risk:Firm-Portfolio ApproachFirm-Portfolio ApproachuuManagerial OptionsManagerial Options14-3An Illustrati

3、on of Total Risk An Illustration of Total Risk(Discrete Distribution)(Discrete Distribution)ANNUAL CASH FLOWS:YEAR 1ANNUAL CASH FLOWS:YEAR 1PROPOSAL APROPOSAL A StateState ProbabilityProbabilityProbability Cash FlowCash FlowCash FlowDeep RecessionDeep Recession.05.05$-3,000$-3,000Mild RecessionMild

4、Recession.25.25 1,000 1,000NormalNormal.40.40 5,000 5,000Minor BoomMinor Boom.25.25 9,000 9,000Major BoomMajor Boom.05.05 13,000 13,00014-4Probability Distribution Probability Distribution of Year 1 Cash Flowsof Year 1 Cash Flows.40.05.25Probability-3,000 1,000 5,000 9,000 13,000Cash Flow($)Proposal

5、 A14-5 CFCF1 1 P P1 1 (CFCF1 1)()(P P1 1)$-3,000$-3,000 .05.05$-150$-150 1,0001,000 .25.25 250250 5,000 5,000 .40.40 2,0002,000 9,000 9,000 .25.25 2,2502,250 13,000 13,000 .05.05 650650 S S S S=1.001.00 CFCF1 1=$5,000$5,000Expected Value of Year 1 Expected Value of Year 1 Cash Flows(Cash Flows(Propo

6、sal AProposal A)14-6 (CFCF1 1)()(P P1 1)(CFCF1 1-CFCF1 1)2 2(P P1 1)$-150$-150 (-3,000-3,000-5,0005,000)2 2(.05.05)250 250 (1,000 1,000-5,0005,000)2 2(.25.25)2,000 2,000 (5,000 5,000-5,0005,000)2 2(.40.40)2,250 2,250 (9,000 9,000-5,0005,000)2 2(.25.25)650 650 (13,000 13,000-5,0005,000)2 2(.05.05)$5,

7、000$5,000Variance of Year 1 Variance of Year 1 Cash Flows(Cash Flows(Proposal AProposal A)14-7Variance of Year 1 Variance of Year 1 Cash Flows(Cash Flows(Proposal AProposal A)(CFCF1 1)()(P P1 1)(CFCF1 1-CFCF1 1)2 2*(*(P P1 1)$-150$-150 3,200,0003,200,000 250 250 4,000,0004,000,000 2,000 2,000 0 0 2,

8、250 2,250 4,000,0004,000,000 650 650 3,200,0003,200,000$5,000$5,000 14,400,00014,400,00014-8Summary of Proposal AThe standard deviation =SQRT(14,400,000)=$3,795 The expected cash flow=$5,00014-9An Illustration of Total Risk An Illustration of Total Risk(Discrete Distribution)(Discrete Distribution)A

9、NNUAL CASH FLOWS:YEAR 1ANNUAL CASH FLOWS:YEAR 1PROPOSAL BPROPOSAL B StateState ProbabilityProbabilityProbability Cash FlowCash FlowCash FlowDeep RecessionDeep Recession.05.05$-1,000$-1,000Mild RecessionMild Recession.25.25 2,000 2,000NormalNormal.40.40 5,000 5,000Minor BoomMinor Boom.25.25 8,000 8,0

10、00Major BoomMajor Boom.05.05 11,00011,00014-10Probability Distribution Probability Distribution of Year 1 Cash Flowsof Year 1 Cash Flows.40.05.25Probability-3,000 1,000 5,000 9,000 13,000Cash Flow($)Proposal B14-11Expected Value of Year 1 Expected Value of Year 1 Cash Flows(Cash Flows(Proposal BProp

11、osal B)CFCF1 1 P P1 1 (CFCF1 1)()(P P1 1)$-1,000$-1,000 .05.05$-50$-50 2,0002,000 .25.25 500500 5,000 5,000 .40.40 2,0002,000 8,000 8,000 .25.25 2,0002,000 11,000 11,000 .05.05 550550 S S S S=1.001.00 CFCF1 1=$5,000$5,00014-12 (CFCF1 1)()(P P1 1)(CFCF1 1-CFCF1 1)2 2(P P1 1)$-50$-50 (-1,000-1,000-5,0

12、005,000)2 2(.05.05)500500 (2,000 2,000-5,0005,000)2 2(.25.25)2,0002,000 (5,000 5,000-5,0005,000)2 2(.40.40)2,0002,000 (8,000 8,000-5,0005,000)2 2(.25.25)550550 (11,00011,000-5,0005,000)2 2(.05.05)$5,000$5,000Variance of Year 1 Variance of Year 1 Cash Flows(Cash Flows(Proposal BProposal B)14-13Varian

13、ce of Year 1 Variance of Year 1 Cash Flows(Cash Flows(Proposal BProposal B)(CFCF1 1)()(P P1 1)(CFCF1 1-CFCF1 1)2 2(P P1 1)$-50$-50 1,800,0001,800,000 500 500 2,250,0002,250,000 2,0002,000 0 0 2,000 2,000 2,250,0002,250,000 550 550 1,800,0001,800,000$5,000$5,000 8,100,000 8,100,000 14-14Summary of Pr

14、oposal BThe standard deviation of Proposal B Proposal A.($2,846-($266.67)-($266.67)What is the“new”“new”project value?14-42Project Abandonment$2,238.32$1,331.29$1,059.18$344.90$72.79-$199.32-$1,280.95-$900-$900(.20.20)$1,200$1,200(.20.20)-$400*-$400*(.6060)$450$450Year 1Year 11 12 23 3(.60)$1,200$1,

15、200(.30)$900$900(.10)$2,200$2,200(.35)$900$900(.40)$600$600(.25)$300$300(1.0)$0$0Year 2Year 2*-$600+$200 abandonment14-43Summary of the Addition of the Abandonment Option*For“True”Project considering abandonment optionThe standard deviation*=SQRT(740,326)=$857.56 The expected NPV*=$71.88 NPV*=Original NPV+Abandonment Option Thus,$71.88 =-$17.01+Option Abandonment Option =$88.89