Question

You have computed the NPV of a project to be $30 million, using expected cash flows and a risk-adjusted discount rate. You are, however, concerned that you may have made errors on estimating the cash flows and the discount rate. Which of the following make you feel more comfortable with taking the project, given this fear?
Select one:
a. The project NPV is very sensitive to changes in your discount rate
b. In your best case scenario, the project has a NPV of $80 million
c. The project has a long payback period
d. The standard deviation in the NPV, when you do a Monte Carlo simulation yields a high value
e. In your worst case scenario, the project has a NPV of $ 3 million

Answer 1

If, the NPV is sensitive to changes in the discount rate, then it would be difficult to take the project. The reason is that a small increase in the discount rate can lead to a negative Net present value.

The best-case scenario would not make the investor feel comfortable if he did not know about the worst-case scenario.

If the project has a long payback period then it is not recommended to select the project as a long payback period means that the project would take a longer time to recover its initial investment.

If the standard deviation is high this means that risk in the project is high. This would not bring confidence in the investor.

If in the worst-case scenario the NPV is positive, then investors would feel comfortable investing in the project. The reason being that the project should be accepted if the NPV of the project is positive. If even in the worst case scenario the NPV is positive this means that project is pretty good and worth investing. So, the correct option is e.