Question

Assume that the net cash flow of a potential $7.25 million investment is $1.1 million in year 1, then $1.25 million in year 2, $1.4 million in year 3, $2.2 million in year 4 and year 5, and then sold at the end of year 5 for $850,000. Further assume that in each year cash flows (excluding initial investment) could be as much as $400,000 less than forecast, or $400,000 more than forecast. Suppose you assess the “low net cash flow” probability at 25 percent likely, the base (original) scenario at 50 percent likely, and the “high net cash flow” probability at 25 percent. The corporate cost of capital is 9 percent.

1. What is the worst case NPV? $ _____

- What is the best case NPV? $_____

-What is the expected NPV on the basis of the scenario analysis? $_______

Answer 1

		Present Value of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Cost of capital=9%=0.09
		N=Year of Cash flow
	I	Initial Cash Flow	($7,250,000)
	1	WORST CASE NPV:
	N	Year	1	2	3	4	5
	a	Base Case Cash In Flow	$1,100,000	$1,250,000	$1,400,000	$2,200,000	$2,200,000
	b=a-400000	WORST CASE Cash Inflow	$700,000	$850,000	$1,000,000	$1,800,000	$1,800,000	SUM
	c=b/(1.09^N)	Present Value of Worst Case Cash In Flow:	$642,202	$715,428	$772,183	$1,275,165	$1,169,876	$4,574,855
	PV	Sum of Present Value of Cash Inflows	$4,574,855
	NPV=PV+I	Worst Case NPV	($2,675,145)	(4574855-7250000)
	2	BEST CASE NPV
	d=a+400000	Best Case Cash Flow	$1,500,000	$1,650,000	$1,800,000	$2,600,000	$2,600,000	SUM
	e=d/(1.09^N)	Present Value of Best Case Cash In Flow:	$1,376,147	$1,388,772	$1,389,930	$1,841,906	$1,689,822	$7,686,576
	PV	Sum of Present Value of Cash Inflows	$7,686,576
	NPV=PV+I	Best Case NPV	$436,576	(7686576-7250000)
	3	EXPECTED NPV
	f=b*25%+a*50%+d*25%	Expected Annual Cash Flow	$1,100,000	$1,250,000	$1,400,000	$2,200,000	$2,200,000	SUM
	g=f/(1.09^N)	Present Value of Expected Cash In Flow:	$1,009,174	$1,052,100	$1,081,057	$1,558,535	$1,429,849	$6,130,716
	PV	Sum of Present Value of Cash Inflows	$6,130,716
	NPV=PV+I	Best Case NPV	($1,119,284)	(6130716-7250000)