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# Chapter7Q05answer - Chapter 7 Question 5 a NPV(\$m 3 to...

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Chapter 7 Question 5 a) Probabilities NPV (\$m) Extend Replace –3 to under –2 0.05 0.00 –2 to under –1 0.05 0.05 –1 to under 0 0.15 0.15 0 to under 1 0.29 0.26 1 to under 2 0.22 0.21 2 to under 3 0.14 0.18 3 to under 4 0.10 0.10 4 to under 5 0.00 0.05 The cumulative probabilities are shown below:- Cumulative probabilities NPV (\$m) Extend Replace –3 to under –2 0.05 0.00 –2 to under –1 0.10 0.05 –1 to under 0 0.25 0.20 0 to under 1 0.54 0.46 1 to under 2 0.76 0.67 2 to under 3 0.90 0.85 3 to under 4 1.00 0.95 4 to under 5 1.00 1.00 The graph shows that the REPLACE option exhibits first order stochastic dominance over the EXTEND option. 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 –4 –2 0 2 4 6 NPV (\$m) Cumulative probability Extend Replace

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b) Probabilities NPV (\$m) Move Replace –3 to under –2 0.00 0.00 –2 to under –1 0.05 0.05 –1 to under 0 0.05 0.15 0 to under 1 0.40 0.26 1 to under 2 0.40
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Chapter7Q05answer - Chapter 7 Question 5 a NPV(\$m 3 to...

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