Question

A project with a 3-year life has the following probability distributions for possible end of year cash flows in each of the next three years: Year 1 Prob then Cash Flow 0.30 $300 0.4 $500 0.3 $700. Year 2 0.15 $100 0.35 $200 0.35 $600 0.15 $900. Year 3 0.25 $200 0.75 $800. Using an interest rate of 8 percent, find the expected present value of these uncertain cash flows. (Hint: Find the expected cash flow in each year, then evaluate those cash flows.) a. $1,204.95 b. $835.42 c. $1,519.21 d. $1,580.00 e. $1,347.61

Answer 1

Calculation of expected cash flow in each year
Year 1			Year 2			Year 3
Probability	Cash flow	Expected Cash flow	Probability	Cash flow	Expected Cash flow	Probability	Cash flow	Expected Cash flow
0.3	$300.00	$90.00	0.15	$100.00	$15.00	0.25	$200.00	$50.00
0.4	$500.00	$200.00	0.35	$200.00	$70.00	0.75	$800.00	$600.00
0.3	$700.00	$210.00	0.35	$600.00	$210.00
			0.15	$900.00	$135.00
Expected Cash flow		$500.00			$430.00			$650.00
Calculation of expected present value of uncertain cash flows.
Year	Expected Cash flow	Discount Factor @ 8%	Present Value
1	$500.00	0.92593	$462.96
2	$430.00	0.85734	$368.66
3	$650.00	0.79383	$515.99
Expected Present Value			$1,347.61
The asnwer is Option e.