Question

The University of Crookington wants to offer one of its courses online. It costs $45,000 to create the necessary infrastructure, and $15,000 to develop the digital content for the first course.

The University estimates that there is a 80% probability of the course being successful, in which case annual cash flows from assets of $8,000 can be expected for 7 years. Otherwise, annual cash flows from assets of only $5,000 can be expected over the same time period.

The University has a weighted average cost of capital of 10% and estimates that the online course would be as risky as its existing assets.

1. What is the NPV of the project?

The University will observe the demand for the first online course over two years. If the course turns out to be successful, the University can offer another 2 courses online by investing $15,000 each for content development in two years and then earning $8,000 per year for 7 years. No additional investment in infrastructure will be required.

2. What is the NPV of the project including this option?

Answer 1

	Part 1: NPV of the Project
			Scenario	Probability	Annual Cash flow	(Probability)*Cash flow
			Successful	0.8	$8,000	$6,400
			Not Successful	0.2	$5,000	$1,000
					SUM	$7,400
		Pmt	Expected annual cash inflow	$7,400
		Nper	Number of years of cash flow	7
		Rate	Weighted Average Cost of Capital	10%
		PV	Present Value of Cash inflows	$36,026.30	(Using PV function of excel with Rate=10%, Nper=7, Pmt=-7400)
		I	Initial cash flow ($ million)	($60,000)	(45000+15000)
		NPV=PV+I	Net Present value (NPV) of the project	($23,973.70)
	Part 2
			Possible outcomes:	Probability
			Successful	0.8
			Not Successful	0.2
			If Successful,
			There will be investment of $30000 for another two courses
			If not successful,there would not be any further investment
			If successful,:Further Cash flows
		Pmt	Expected annual cash inflow fromyear5	$8,000
		Nper	Number of years of cash flow	7
		Rate	Average Cost of Capital	10%
		PV	Present Value of Cash inflows at year4	$38,947.35	(Using PV function of excel with Rate=10%, Nper=7, Pmt=-8000)
		I	Initial cash flow	($30,000)
		NPV=PV+i	NPV in year 4	$8,947.35	(withProbability0.8)
			YEAR 4outcomes:	Probability	NPV of project	(Probability)*NPV
			Successful	0.8	$8,947.35	$7,157.88
			Not Successful	0.2	$0	$0.00
					SUM	$7,157.88
			Expected NPV in year 4	$7,157.88
		PV1	Present Value of Cash inflows(NPV in year4)	$4,888.93	(7157.88/(1.1^4)
		NPV	Net Present value (NPV) of originalcourses	($23,973.70)	(10.88-0.2)
		PV1+NPV	NPV of the project including the option	($19,084.77)