Unformatted text preview: this isn’t 10% as you might hope! The 2year returns are 43,388/18,646 – 1 = 132.69% in the good state and 8,678/18,646 – 1 = 53.46% in the bad state. The expected value of these is 132.69% (0.40)  53.46% (0.60) = 21.0%, which is exactly 10% compounded twice: 0.21 = (1.10) 2 – 1.] The variance is σ 2 = (0.5254  0.0195) 2 (0.40) + (0.3178 – 0.0195) 2 (0.60) = 0.1706 To calculate the variance of the project’s returns using the indirect method, first calculate the standard deviation of the value at year 2. The value is either 43,388 (probability 40%) or 8,678 (probability 60%). Expected value at year 2: 43,388(0.4) + 8,678(0.6) = 22,562. Standard deviation = [(43,38822,562) 2 (0.40) + (8,678 – 22,562) 2 (0.60)] 1/2 = 17,004....
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 Spring '08
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 Variance, Net Present Value, Probability theory

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