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Now that we know how to calculate and apply these

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Unformatted text preview: late the expected return: Possible outcome, xi Probability, pi -0.10 0.00 0.20 0.20 0.50 0.30 xi pi -0.02 0.00 0.16 E(x)=0.04 Then, calculate the variance xi- E (x) (xi- E (x))2 -0.14 -0.04 0.16 0.0196 0.0016 0.0256 pi (xi- E (x))2 0.00392 0.00080 0.00768 Risk can be expressed statistically in terms of measures such as the range, the standard deviation, and the coefficient of variation. Now that we know how to calculate and apply these statistical measures, all we need are the probability distributions of the project's future cash flows so we can apply these statistical tools to evaluate a project's risk. Where do we get these probability distributions? From research, judgment, and experience. We can use sensitivity analysis or simulation analysis to get an idea of a project's possible future cash flows and their risk. Estimates of cash flows are based on assumptions about the economy, competitors, consumer tastes and preferences, construction costs, and taxes, among a host of other possible assumptions. One...
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