A research project would require initial investment of 100,000. There are three possible outcomes for this...

A research project would require initial investment of 100,000. There are three possible outcomes for this project:

a.) 30% probability that investment yields annual income of 35,000 for six year (starting from year 1 to year six) and zero salvage value
b.) 50% probability that investment yields annual income of 25,000 for six year (starting from year 1 to year six) and zero salvage value
c.) 20% probability of failure that yields zero annual income but salvage value of 75,000 dollar at the end of year 1

Calculate expected Rate of Return for this investment. Explain your work in detail including all the required equations and calculations.

Expert Solution

In this question, we need to calculate the rate of return. This question would not be a straight forward and would require a trial and error method. You would be a financial calculator or excel sheet to calculate the rate. I have used excel.

What I have done is – I have created an excel model for this calculation so that while we are doing our trial and error, it is super easy.

First calculate the present value of each outcome with assuming any random rate of return and then multiply them by their probability and sum them to get ENPV. We will compare our answer with initial investment – If the difference is coming near to zero that would be the rate. While we will use the excel sheet, we would need to adjust our assumed rate of interest to reach to the number 0 as difference between ENPV and initial investment. Please see below the screenshot.

Rate of return required for this projest is 15.03525%

Formula for NPV =

jeff jeffy answered 2 years ago

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