by 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
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