Question

In: Finance

You are evaluating a project and during the initial evaluation you determine that there are nine...

  1. You are evaluating a project and during the initial evaluation you determine that there are nine states that could occur along two variables. The first variable is the cost of money, and you predict the following costs and probabilities:

-- the company could borrow at a weighted average cost of capital of 8% -- this has a 25% chance of occurring

-- the company could borrow at a weighted average cost of capital of 9%-- this has a 40% chance of occurring

-- the company could borrow at a weighted average cost of capital of 10% -- this has a 35% chance of occurring

The second variable is the intensity of competition, and you predict the following intensities and probabilities:

-- the competition is intense -- this has a 20% chance of occurring

-- the competition is normal -- this has a 50% chance of occurring

-- the competition is weak -- this has a 30% chance of occurring

The net present values for each of the nine outcomes are listed below:

Net Present Values:

Weighted Average Cost of Capital

Note

Bracketed numbers are negative

8.00%

9.00%

10.00%

25.00%

40.00%

35.00%

Competition

Intense

20.00%

$ 500,000

$ (50,000)

$ (100,000)

Competition

Normal

50.00%

$ 700,000

$   350,000

$ 100,000

Competition

Weak

30.00%

$ 900,000

$ 650,000

$ 300,000

Joint Probabilities:

Weighted Average Cost of Capital

8.00%

9.00%

10.00%

25.00%

40.00%

35.00%

Competition

Intense

20.00%

Competition

Normal

50.00%

Competition

Weak

30.00%

Expected value

___________________________

Please enter the joint probabilities and the expected net present value in the boxes above.

_________________

Solutions

Expert Solution

Calculation of joint probability

Probability of intense competition = 20%

Probability of Company borrowing at a WACC of 8% = 25%

So, Joint Probability of intense competition & Company borrowing at a WACC of 8%

= 20% * 25% = 5%

Similarly, other joint probabilities are calculated and calculated joint probabilities are as follows

8.00%

9.00%

10.00%

25.00%

40.00%

35.00%

Competition

Intense

20.00%

5.00%

8.00%

7.00%

Competition

Normal

50.00%

12.50%

20.00%

17.50%

Competition

Weak

30.00%

7.50%

12.00%

10.50%

Net present values for each of the nine outcomes is given as follows –

8.00%

9.00%

10.00%

25.00%

40.00%

35.00%

Competition

Intense

20.00%

      500,000

       (50,000)

      (100,000)

Competition

Normal

50.00%

      700,000

      350,000

        100,000

Competition

Weak

30.00%

      900,000

      650,000

        300,000

Expected Net Present value is calculated by multiplying Net Present Value for an outcome by the joint probability for that outcome.

For example, Expected net present value for outcome of intense competition & Company borrowing at a WACC of 8% = 5% * 500,000 = $25,000

Similarly, Expected net present values for nine outcomes is calculated and the values are as follows

8.00%

9.00%

10.00%

25.00%

40.00%

35.00%

Competition

Intense

20.00%

        25,000

         (4,000)

          (7,000)

Competition

Normal

50.00%

        87,500

        70,000

          17,500

Competition

Weak

30.00%

        67,500

        78,000

          31,500

Now, Total Expected Net Present Value is the sum of the individual expected net present value calculated for the nine outcomes

Expected Net Present Value = 25000 -4000 -7000 +87500+70000+17500+67500+78000+31500

Expected Net Present Value = $366,000

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

You are evaluating a project for your company. The initial outlay for the project is $5,000,000,...
You are evaluating a project for your company. The initial outlay for the project is $5,000,000, and free cash flows for the project are $1,000,000, $3,000,000, $3,000,000, $4,000,000 and $4,000,000. For risk analysis, you utilize the Payback and Discounted Payback methods to trigger increased risk scrutiny. Your standard is, any project that goes longer than 3 years under either metric will go through these increased risk tests. If your required rate is 12%, does this project qualify for increased scrutiny?...
You are evaluating the following project. All $ are in millions Initial cost of the project...
You are evaluating the following project. All $ are in millions Initial cost of the project at t=0 is $70. Annual cash flows from the project depends on the demand for the product and is estimated to be as follows: With probability of 30%, the demand is high and the annual cash flow is $45 With probability of 40%, the demand is average and the annual cash flow is $30 With probability of 30%, the demand is low and the...
You are evaluating the following project. All $ are in millions Initial cost of the project...
You are evaluating the following project. All $ are in millions Initial cost of the project at t=0 is $70. Annual cash flows from the project depends on the demand for the product and is estimated to be as follows: With probability of 30%, the demand is high and the annual cash flow is $45 With probability of 40%, the demand is average and the annual cash flow is $30 With probability of 30%, the demand is low and the...
A). You are evaluating a project with the following cash flows: initial investment is $-12, and...
A). You are evaluating a project with the following cash flows: initial investment is $-12, and the expected cash flows for years 1 - 3 are $10, $11 and $17 (all cash flows are in millions of dollars). What is this projects NPV? The company's WACC is 10%. B). You are evaluating a project with an initial investment of $16.9 million dollars, and expected cash flows of $7 million dollars each for years 1-3. What is the project's simple payback?...
Question 1: You are evaluating whether the use of red lights during evaluation has a significant...
Question 1: You are evaluating whether the use of red lights during evaluation has a significant effect on liking. Liking was measured as either like or dislike. You collected the below data. Using the Sign Test, did the wine glass significantly influence liking? There is a worked example using the sign test   (5 pts) Panelist Liking of wine: No red light Liking of wine: With Red light Direction of change 1 Like Like 2 Dislike Like 3 Dislike Like 4...
You are evaluating a project with the following cash flows: initial investment is $-23, and the  expected...
You are evaluating a project with the following cash flows: initial investment is $-23, and the  expected cash flows for years 1 - 3 are $12, $9 and $8 (all cash flows are in millions of dollars). What is this projects NPV? The company's WACC is 9%. Express your answer in millions of dollars, rounded to 2 decimals and without the dollar sign. So, if your answer is 23.5678, just enter 23.57.
You are evaluating a mining project that will require an initial investment outlay (time 0) of...
You are evaluating a mining project that will require an initial investment outlay (time 0) of $700,000. The project will generate cash flows of $200,000 in Year 1, $300,000 in Year 2, and $400,000 in Year 3. There are no cash flows beyond Year 3. Show work in excel A. What is the NPV of the project at a discount rate of 10%? Explain calculations. B. What is the IRR of the project? Explain calculations. C. Should you invest in...
You are evaluating a project (initial investment is $41,000) that is expected to produce cash flows...
You are evaluating a project (initial investment is $41,000) that is expected to produce cash flows of $5,000 each year for the next ten years and $7,000 each year for the following ten years. The IRR of this project is 12%. The firm’s WACC is 8%. What is the project’s NPV?
We are evaluating a project that costs $710,000, has a life of nine years, and has...
We are evaluating a project that costs $710,000, has a life of nine years, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 122,000 units per year. Price per unit is $43, variable cost per unit is $21, and fixed costs are $714,970 per year. The tax rate is 24 percent, and we require a return of 13 percent on this project. The projections given for price,...
We are evaluating a project that costs $933,000, has a life of nine years, and has...
We are evaluating a project that costs $933,000, has a life of nine years, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 127,000 units per year. Price per unit is $35, variable cost per unit is $20, and fixed costs are $935,799 per year. The tax rate is 23 percent, and we require a return of 19 percent on this project. The projections given for price,...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT