Question

You are trying to get an idea of how predictable a firm future FCF’s will be so you look at the last 10 years FCF’s and find that the average was 25 million and that the standard deviation was 18 million. You decide to find the range of outcomes 95% of the time. How should you interpret this?

a. The range of outcomes are from 7 to 43 million

b. The range of outcomes are from -11 to 61 million and the smaller the standard deviation the lower the total risk

c. The range of outcomes are from -11 to 61 million and the smaller the standard deviation the higher the total risk

d. The range of outcomes are from 5 to 45 million

Answer 1

	Mean FCF	25	million
	Standard Deviation of FCF	18	million
	As per 68-95-99.7 rule
	95% probability will be 2 sigma events
	Z=(X-Mean)/Standard Deviation
	Value of Z with a range of -2 and +2 will have probability of 95%
	Range for 95% outcomes:
	Lower Range :(X-25)=-2*18; X=-11
	Higher Range :(X-25)=2*18: X=61
	Hence, the range of outcome are from -11 to 61
	Standard deviation indicates the amount of risk
	Higher the standard deviation , higher the risk
	Hence, Lower the Standard Deviation , Lowr the risk
	ANSWER :
	b. The range of outcomes are from -11 to 61 million
	and the smaller the standard deviation the lower the total risk