Question

A firm is considering investing $10 million today to start a new product line. The future of the project is unclear however and depends on the state of the economy. The project will last 5 years. The yearly cash flows for the project are shown below for the different states of the economy. What is the expected NPV for the project if the cost of capital is 12%? (Show your work. Label $. No decimal places required. Highlight or bold your answer.)

Project	Chance of	Yearly
Outcome	Outcome	Cash Flow
GOOD	25%	$8,000,000
AVERAGE	50%	$3,000,000
BAD	25%	($2,000,000)

Answer 1

Step-1:Calculation of expected annual cash flow
Project outcome	Chance of outcome	Yearly cash flow
	a	b	c=b*a
GOOD	25%	$         80,00,000	$ 20,00,000
AVERAGE	50%	$         30,00,000	$ 15,00,000
BAD	25%	$       -20,00,000	$ -5,00,000
Total		Expected cash flow	$ 30,00,000
Step-2:Calculation of expected NPV
Expected present value of annual cash flow		$         30,00,000	*	3.604776	=	$       1,08,14,329
Less cost of project						$       1,00,00,000
Expected NPV						$             8,14,329
Working:
Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
	=	(1-(1+0.12)^-5)/0.12		i	12%
	=	3.604776202		n	5