This preview shows page 1. Sign up to view the full content.
Unformatted text preview: each possible outcome with this one value. A common approach is to use a measure of central
location of a probability distribution, the expected value.
Let's use N to designate the number of possible future outcomes, xn to indicate the nth possible outcome,
pn to indicate the probability of the nth outcome occurring, and E (x) to indicate the expected outcome.
The expected cash flow is the weighted average of the cash flows, where the weights are the
probabilities:
E(x) = x1p1 + x2p2 + x3p3 +...+ xnpn + ... + xNpN
Expected value = E (x) = N ∑ pn xn n=1 Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 4 The standard deviation is a measure of how each possible outcome deviates  that is, differs  from
the expected value. The standard deviation provides information about the dispersion of possible
outcomes because it provides information on the distance each outcome is from the expected value and
the likelihood the outcome will occur. The standard deviation is:
Standard deviation
of possible outcomes = σ(x) = N ∑ pn (xn − ε(x))2 n =1 We begin our calculation of standard deviatio...
View Full
Document
 Spring '07
 MEJIAS

Click to edit the document details