13.7 Expected net present value

Question 1

What is the methodology for calculating expected net present value (NPV)?

Answer 1

1 The probability of an outcome is calculated
2 The expected value of each probable outcome is calculated
3 All expected values are added together, multiplied by their probability, to give an expected value

i.e: Expected value = ΣPX

Question 2

What are the advantages of the expected net present value method of risk assessment?

Answer 2

• provides a clear decision making rule (either the investment is profitable or it is not).
• easy to calculate

Question 3

What are the disadvantages of the expected net present value method of risk assessment?

Answer 3

• does not account for volatility of an investment (which may only be measured by standard deviation)
• probabilities are somewhat subjective and difficult to calculate

Question 4

What is standard deviation?

Answer 4

S statistical tool that measures the amount of variation or dispersion of a set of data from its mean.

Question 5

How is standard deviation calculated?

Answer 5

The square root of variance

Question 6

What is the “coefficient of variation”?

Answer 6

The ratio of standard deviation to the mean, measuring the extent of variability in the dispersion of data points in a dataset in relation to the mean of the population.

Question 7

How is “coefficient of variation” calculated?

Answer 7

standard deviation / expected net present value