The Xyz Company Has Estimated Expected Cash Flows For 1996

5 The Xyz Company Has Estimated Expected Cash Flows For 1996 To Be

The Xyz Company has estimated expected cash flows for 1996 with associated probabilities. The task involves calculating the expected value, standard deviation, coefficient of variation, and the probability that the cash flow will be less than $100,000.

Given data:

  • Probability 0.10, Cash flow $120,000
  • Probability 0.15, Cash flow $140,000
  • Probability 0.50, Cash flow $150,000
  • Probability 0.15, Cash flow $180,000
  • Probability 0.10, Cash flow $210,000

Sample Paper For Above instruction

The estimation of expected cash flows is a fundamental aspect of financial risk analysis, allowing decision-makers to understand the average potential outcomes considering the probabilities of various cash flows. This paper will compute the expected value, standard deviation, coefficient of variation, and the probability that cash flows will be less than $100,000 based on the given probability distributions for the Xyz Company in 1996.

Calculation of Expected Value

The expected value (EV) is a weighted average of all potential cash flows, calculated as:

EV = Σ (probability x cash flow)

Applying the formula:

EV = (0.10 x 120,000) + (0.15 x 140,000) + (0.50 x 150,000) + (0.15 x 180,000) + (0.10 x 210,000)

Calculations:

EV = 12,000 + 21,000 + 75,000 + 27,000 + 21,000 = $156,000

The expected cash flow for 1996 is therefore $156,000.

Calculation of Standard Deviation

The standard deviation measures the dispersion of cash flows around the mean, calculated as:

σ = √(Σ [probability x (cash flow - EV)^2])

Calculations:

Variance = (0.10 x (120,000 - 156,000)^2) + (0.15 x (140,000 - 156,000)^2) + (0.50 x (150,000 - 156,000)^2) + (0.15 x (180,000 - 156,000)^2) + (0.10 x (210,000 - 156,000)^2)

Computing each component:

  • (120,000 - 156,000) = -36,000; squared = 1,296,000,000; contribution = 0.10 x 1,296,000,000 = 129,600,000
  • (140,000 - 156,000) = -16,000; squared = 256,000,000; contribution = 0.15 x 256,000,000 = 38,400,000
  • (150,000 - 156,000) = -6,000; squared = 36,000,000; contribution = 0.50 x 36,000,000 = 18,000,000
  • (180,000 - 156,000) = 24,000; squared = 576,000,000; contribution = 0.15 x 576,000,000 = 86,400,000
  • (210,000 - 156,000) = 54,000; squared = 2,916,000,000; contribution = 0.10 x 2,916,000,000 = 291,600,000

Total variance = 129,600,000 + 38,400,000 + 18,000,000 + 86,400,000 + 291,600,000 = 564,000,000

Standard deviation, σ = √564,000,000 ≈ $23,769.55

Coefficient of Variation

The coefficient of variation (CV) indicates the relative risk per unit of expected return, calculated as:

CV = σ / EV

Thus:

CV = 23,769.55 / 156,000 ≈ 0.1524 or 15.24%

This suggests that the cash flows have a moderate level of relative risk.

Probability of Cash Flows Less Than $100,000

Since none of the cash flows specified are below $100,000, and the probability distribution assigns zero probability to these outcomes, the probability that cash flows are less than $100,000 is zero.

Therefore, P(cash flow

In conclusion, the Xyz Company can expect an average cash flow of $156,000 in 1996, with a standard deviation of approximately $23,769.55, indicating the variability of expectations around this mean. The risk per unit of return, as indicated by the coefficient of variation, stands at approximately 15.24%, reflecting a moderate level of risk. Also, there is no probability that cash flows will fall below $100,000 based on the given distribution.

References

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