Chapter 13, Problem 21P

a.

Summary Introduction

To calculate: The standard deviations of Year 1, Year 5, and Year 10.

Introduction:

Standard deviation (SD):

A statistical tool that helps measure the deviation or volatility of an investment is termed as the standard deviation. It is the square root of variance.

b.

Summary Introduction

To draw: The diagram of the mean (expected value) and SD for three years.

Introduction:

Expected value:

It is also known as mean. It is the value that is estimated or anticipated to earn in the future from an investment. It is computed by adding up the values that occur by multiplying each of the outcomes with their probabilities.

Standard deviation (SD):

A statistical tool that helps measure the deviation or volatility of an investment is termed as the standard deviation. It is the square root of variance.

c.

Summary Introduction

To calculate: The values and differences in the values of discount rates of 6% and 12% at Year 1, Year 5, and Year 10.

Introduction:

Discount Rate:

A rate that is used for the calculation of the present value of the cash flows is termed as the discount rate.

d.

Summary Introduction

To explain: The relation between the increase in risk overtime shown in the diagram in part (c) and the large differences in PVIFS computed in the part (b).

Introduction:

Risk:

The future uncertainty of the deviation between actual and expected outcome is termed as risk. Risk is the quantified representation of uncertainty that an investor is willing to take on the investments.

e.

Summary Introduction

To calculate: The investment is accepted on the basis of the NPV or not.

Introduction:

Net present value (NPV):

It is the difference between the PV (present value) of cash inflows and the PV of cash outflows. It is used in capital budgeting and planning of investment to assess the benefits and losses of any project or investment.