Unformatted text preview: ation provides a useful measure of dispersion. It is a measure of how widely dispersed
the possible outcomes are from the expected value. However, we cannot compare standard deviations of
different projects' cash flows if they have different expected values.
We can do that with the coefficient of variation, which translates the standard deviation of different
probability distributions (because their scales differ) so that they can be compared.
The coefficient of variation for a probability distribution is the ratio of its standard deviation to its
Coefficient of variation = Standard deviation / Expected value
Coefficient of variation = Capital budgeting & risk, a reading prepared by Pamela Peterson Drake σx
εx 5 Example: Expected return and standard deviation Consider investing in a project whose possible returns
next period and associated probabilities are:
Possible outcome Probability -10%
What is this project's expected return and standard
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- Spring '07