An investment opportunity has the potential of generating yearly revenues with t
ID: 1099870 • Letter: A
Question
An investment opportunity has the potential of generating yearly revenues with the associated probabilities for the next five years as shown below. The salvage value at the end of five years is 0. The potential revenue in any given year is independent of any other year. Determine the mean and standard deviation of the present worth, using an interest rate of 12%.
Potential Revenue, $
Probability
20,000
0.30
30,000
0.40
50,000
0.20
60,000
0.10
$120,570; $48,901
$48,901; $50,901
$122,570; $25,000
$122,570; $48,901
Potential Revenue, $
Probability
20,000
0.30
30,000
0.40
50,000
0.20
60,000
0.10
Explanation / Answer
$120,570; $48,901-----------answer
Expected annual revenue = $20,000(0.3) + 30,000(0.4) + 50,000(0.2) + 60,000(0.1) = $34,000
Expected net present worth = -$100,000 + 34,000(P/A, 12%, 5) = -$100,000 + 34,000(3.605) = $22,570
Yes, the net present worth at the MARR is positive, therefore the investment is attractive. However, we mightwant to perform sensitivity analysis to determine the range of NPW values. The $20,000 level (with 30%probability) clearly produces a loss while the $30,000 level (with 40% probability) will produce a small gain.After the sensitivity analysis, the investment might not appear as attractive given the range of possibleoutcomes, although the expected NPW is positive. The decision of whether or not to accept the alternativebased on sensitivity analysis depends on individual tolerance for risk
a.$120,570; $48,901-----------answer
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