KLM Ltd., is considering taking up one of the two projects-Project-K and Project-S. Both the projects having same life require equal investment of…

CA Final · Advanced Financial Management · MTP · September 2025
KLM Ltd., is considering taking up one of the two projects-Project-K and Project-S. Both the projects having same life require equal investment of 80 lakhs each. Both are estimated to have almost the same yield. As the company is new to this type of business, the cash flow arising from the projects cannot be estimated with certainty. An attempt was therefore, made to use probability to analyse the pattern of cash flow from other projects during the first year of operations. This pattern is likely to continue during the life of these projects. The results of the analysis are as follows: Project K Project S Cash Flow (in ₹) Probability Cash Flow (in ₹) Probability 11 0.10 09 0.10 13 0.20 13 0.25 15 0.40 17 0.30 17 0.20 21 0.25 19 0.10 25 0.10 Evaluate which of the two projects is riskier?

Suggested Answer and Working Notes:

Calculation of Variance and Standard Deviation Project K Expected Net Cash Flow = (0.10 x 11) + (0.20 x13) + (0.40 x 15) + (0.20 x 17) + (0.10 x 19) = 1.1 + 2.6 + 6 + 3.4 + 1.9 = 15 σ² = 0.10 (11 – 15) 2 + 0.20 (13-15) 2 + 0.40 (15 – 15) 2 + 0.20 (17 – 15) 2 + 0.10 (19 – 15) 2 = 1.6 + 0.8 + 0 + 0.8 + 1.6 = 4.8 σ= √4.8 = 2.19 Project S Expected Net Cash Flow = (0.10 X 9) + (0.25 X 13) + (0.30 X 17) + (0.25 X 21) + (0.10 X 25) = 0.9 + 3.25 + 5.1 + 5.25 + 2.5 = 17 σ² = 0.1 (9-17) 2 + 0.25 (13-17) 2 + 0.30 (17-17) 2 + 0.25 (21-17) 2 + 0.10 (25-17) 2 = 6.4 + 4 + 0 + 4 + 6.4 = 20.8 σ= √20.8 = 4.56 Calculation of Coefficient of Variation Coefficient of Variation = Standard Deviation / Mean Project K = 2.19 / 15 = 0.146 Project S = 4.56 / 17 = 0.268 Project S is riskier as it has higher Coefficient of Variation.

Topics: Advanced Capital Budgeting Decisions

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