M. Stewart is analyzing a project and has determined that the initial cost will be $615,000...

M. Stewart is analyzing a project and has determined that the initial cost will be $615,000 and the required rate of return needs to be 13 percent. The project has a 65 percent chance of success and a 35 percent chance of failure. If the project fails, it will generate an annual after-tax cash flow of $130,000. If the project succeeds, the annual after-tax cash flow will be $290,000. 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 $250,000. If however, the project is a success, she can expand it with no additional investment and increase the after-tax cash flow to $310,000 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?

		$149,307.25
		$160,590.26
		$174,128.57
		$182,028.97
		$199,916.79

Expert Solution

Expected NPV

$ 199,916.79

If the Project is Failure: Probability = 35%

	Computation of NPV
	Year	Cashflows	PVF@ 13 %	PV

A	0	$ (615,000)	1.0000	$ (615,000)

		PV of Cash Outflows		$ (615,000)

B	1	$ 130,000	0.8850	$ 115,044
	1	$ 250,000	0.8850	$ 221,239
		PV of Cash Inflows		$ 336,283

C	NPV	= B-A		$ (278,717)

If the Project is Success: Probability = 65%

	Computation of NPV
	Year	Cashflows	PVF@ 13 %	PV

A	0	$ (615,000)	1.0000	$ (615,000)

		PV of Cash Outflows		$ (615,000)

B	1	$ 290,000	0.8850	$ 256,637
	2	$ 310,000	0.7831	$ 242,775
	3	$ 310,000	0.6931	$ 214,846
	4	$ 310,000	0.6133	$ 190,129
	5	$ 310,000	0.5428	$ 168,256
		PV of Cash Inflows		$ 1,072,643

C	NPV	= B-A		$ 457,643

Outcome	Probability	NPV	Expected NPV
Success	65%	$ 457,643	$ 297,467.67
Failure	35%	$ (278,717)	$ (97,550.88)
-	-	Expected NPV	$ 199,916.79

jeff jeffy answered 2 years ago

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