Question

A project with an initial outlay of Tshs 10 million has a 0.2 probability of producing a return of Tshs 8 million in Year 1 and a 0.8 probability of delivering a return of Tshs 5 million in Year 1. If the Tshs 8 million result occurs then the second year could return either Tshs 7 million (probability of 0.5) or Tshs 3 million (probability of 0.5). If the Tshs 5 million result in Year 1 occurs then either Tshs 6 million (probability (0.7) or Tshs 4 million (probability 0.3) could be received in the second year. All cash flows occur on anniversary dates. The discount rate is 12 percent. Calculate the expected return and standard deviation.

Answer 1

Particular	Period	Amount in Million	Cost of Capital at 12%	Present Value
Outflow
Initial Outlay	-	10.00	1.00	10.00
Total Outflow (A)				10.00
Inflow
Return	1	5.60	0.89	5.00
Return	2	5.32	0.80	4.24
Total Inflow (B)				9.24
Present Value of Net Inflow (B) - (A)				-0.76

Year 1	Return	Probability	Probable Return
	8	0.2	1.6
				5	0.8	4
	Probable return		5.6

Year 2	Return	Probability	Probable Return	Total Return	Probable Return based on Year 1
	7	0.5	3.5	5	5 * 0.2 = 1
	3	0.5	1.5
	6	0.7	4.2	5.4	5.4 * 0.8 = 4.32
	4	0.3	1.2
Probable Return for Year 2					5.32