Question

Victoria M. is analyzing a project and has determined that the initial cost will be $1,380,000 and the required rate of return needs to be 16 percent. The project has a 60 percent chance of success and a 40 percent chance of failure. If the project fails, it will generate an annual after-tax cash flow of $242,000. If the project succeeds, the annual after-tax cash flow will be $666,000. She has further determined that if the project fails, she will shut it down after the first year and sell the equipment for the after-tax salvage value of $420,000. If however, the project is a success, she can expand it with no additional investment and increase the after-tax cash flow to $697,000 a year for Years 2-5. At the end of Year 5, the project would be terminated and have no salvage value. What is the expected net present value of this project at Time 0?

		$171,480.74
		$183,667.21
		$201,500.99
		$227,615.75
		$239,518.20

Answer 1

NPV if project success
Year	Cash flow	PVIF @ 16%	Present value
0	-1,380,000	1.0000	(1,380,000.00)
1	666000	0.8621	574,137.93
2	697000	0.7432	517,984.54
3	697000	0.6407	446,538.40
4	697000	0.5523	384,946.90
5	697000	0.4761	331,850.77
			875,458.54
NPV (Success) =			875,458.54
NPV if project fail
Year	Cash flow	Salvage value	Total cash flow	PVIF @ 16%	Present value
0	-1,380,000		-1,380,000	1.0000	(1,380,000.00)
1	242000		242,000	0.8621	208,620.69
1		420000	420,000	0.8621	362,068.97
					(809,310.34)
NPV (Failure) =					(809,310.34)
Therefore NPV of the project = Probability of success*NPV of success + probability of failure * NPV of failure
NPV =			=875458.54*.6-809310.34*.4
			201,550.99
Therefore correct answer =			201,550.99