Probability Analysis

question 23

Essay

Probability Analysis. The Medical Centre is considering taking on a new lease for additional office space in alternative suburban shopping areas. Alternative 1 requires a current investment outlay of $50,000; alternative 2 requires an outlay of $75,000. The following cash flows will be generated each year over an initial five-year lease period.
A. Calculate the expected cash flow for each investment alternative.
B. Calculate the standard deviation and coefficient of variation of cash flows (risk) for each investment alternative.
C. The firm will use a discount rate of 15% for the cash flows with higher degree of dispersion and a 12% rate for the less risky cash flows, calculate the expected net present value for each investment. Which alternative should be chosen?

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Definitions:

Predetermined Level

A set benchmark or standard established in advance to guide production activities or cost estimations.

Cost Variance

The difference between the expected (budgeted) cost of an activity and its actual cost.

Standard Cost

A predetermined cost serving as a benchmark for evaluating the actual cost performance of activities.

Actual Cost

The actual expenses incurred in producing a product or delivering a service, including all direct labor, materials, and overhead costs.