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You are considering a project with an opportunity cost of 10% and that offers up the...

You are considering a project with an opportunity cost of 10% and that offers up the following two possible payouts based on your ability to market the product:

In the optimistic state you expect the following payouts, -$4,795, $8,000, $8,000. Based on your pessimistic expectations you expect the following -$4,795, -$500, -$10,000. The cash flows fall at time period 0, 1 and 2.

Your sense is that there is a 40% chance things will turn out well and a 60% chance things will turn out poorly. What is your expected NPV if you are able to abandon the project after year one?

Solutions

Expert Solution

a b a*b
Optimistic Cashflow Pessimistic Cashflow Probable cashflow (cashflow* probability) PV factor 10% [1/(1+r)]^n PV
Probability 40% 60%
Year
0 (4,795.00)     (4,795.00)                 (4,795.00)          1.000 (4,795.00)
1    8,000.00        (500.00)                  2,900.00          0.909    2,636.36
2    8,000.00 (10,000.00)                 (2,800.00)          0.826 (2,314.05)
Expected NPV of the project (4,472.69)
Project should be abandoned after 1st year since expected NPV is negative
Notes:
NPV = Discounted inflow - Initial investment
Rate of return is 10%

jeff jeffy answered 3 weeks ago
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