In an effort to update its pro forma budget, Morningside Deliveries is attempting to determine the level of service, and therefore income, which will come from a new four-year contract. Morningside assigns a probability of 25% that the customer will require minimum service and provide a NPV of $28,000. The company estimates a 50% probability that medium service will be required and will generate at NPV of $32,000. There is only a likelihood of 25% that the customer will need maximum servicing and produce an NPV of $36,000. What is the standard deviation of the income from the contract?

Question

Quizplus · Accepted Answer

To calculate the standard deviation, we first need to find the expected value of the contract income.

Expected value = (0.25 x 28000) + (0.5 x 32000) + (0.25 x 36000) 
Expected value = $32,000

Now we can calculate the standard deviation using the probability weighted variance formula:

Standard deviation = √[(0.25 x (28000 - 32000)^2) + (0.5 x (32000 - 32000)^2) + (0.25 x (36000 - 32000)^2)] 
Standard deviation = $5,657

Therefore, the best choice is C.

In an Effort to Update Its Pro Forma Budget, Morningside