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Inca, Inc. Case 21
Capital Budgeting with Risk
Purpose: The student goes through the statistical procedure of determining risk for investments. Though
one investment alternative provides the higher net present value, is also has a much higher coefficient of
variation and the student must take this into consideration in describing his or her results. The case is
then expanded into six alternatives for which the student is asked to select the lowest risk option.
Relation to Text: This case should follow Chapter 13.
Complexity: This case is straightforward and should require 30-45 minutes to solve.
Solutions
1. Expected value of the net present value (standard)
Outcome Probability Expected Value
Expected value = $632,000
2. Expected value of the net present value (expanded)
Outcome Probability Expected Value
2
4. Standard deviation ( )
Outcome
Expected value
Probability
D D P
D
D
P
= S -
=
=
=
D
–
D
=
( )D D-
2
( )D D-
x
P
=
2
( )D D P-
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
208,336.0
4.4560.336,208
= $456,400 vs. $1,415,800 expanded
Standard deviation
5. Coefficient of variation ( ) Expected value
V=
Standard size restaurant Expanded restaurant
Standard deviation
Expected value
722.
000,632
400,456$
141.1
800,240,1$
800,415,1$
6. Based on the coefficient of variation, the standard size restaurant is much less risky (.722 versus
1.141).
Earlier in question two, the preference was clearly for expanded size restaurants. The general
principle is that you may not wish to always go with the highest return. Risk must be considered as
well.
7. Coefficient of variation
4 standard, 1 expanded $ 641,630 / 753,760 = .851
3 standard, 2 expanded 832,460 / 875,420 = .951
2 standard, 3 expanded 1,025,800 / 997,280 = 1.028
1 standard, 4 expanded 1,220,400 / 1,119,040 = 1.091
Based on the answer to question five as well as this question, the lowest-risk alternative is still the
five standard restaurants with a coefficient of variation of .722.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
