Standard Deviation Method

13th October 2021 0 By indiafreenotes

The immediate earlier approach, viz., the Probability Assignment Approach, through the calculation of expected monetary value, does not supply a precise value about the variability of cash flow to the decision-maker.

Two Projects have the same cash outflow and their net values are also the same, standard durations of the expected cash inflows of the two Projects may be calculated to measure the comparative and risk of the Projects. The project having   a higher standard deviation in said to be riskier as compared to the other.

Example

From the following information, ascertain which project should be selected on the basis of standard deviation.

Project X Project Y
Cash inflow Probability Cash inflow Probability
Rs. Rs.
3,200 .2 32,000 .1
5,500 .3 5,500 .4
7,400 .3 7,400 .4
8,900 .2 8,900  .1

Solution

Project X

Cash inflow Deviation from Mean (d) Square Deviations d2 Probability Weighted Deviations (td2)
1 2 3 4 5
3,200 (-) 6,250 9,30,25,000 .2 18,60,500
5,500 (-) 750 56,2,500 .3 1,68,750
7,400 (+) 1,150 13,22,500 .3 3,96,750
8,900 (+) 2,650 70,22,500 .2 14,04,500

n= 1 , ∑fd2 = 38,30,500

Standard Deviation (6)

= √(∑fd2/n)

= √(3830500/1)

= 1957.2