Consider a project with an initial cost of $1,000 in Year 0, in which 3 scenario
ID: 2625356 • Letter: C
Question
Consider a project with an initial cost of $1,000 in Year 0, in which 3 scenarios can occur, with the probabilities and cash flows (CF) as shown in the table. The appropriate cost of capital is 11.5%.
Scenario
Probability
Year 1
Year 2
Year 3
High
30%
800
800
800
Average
40%
500
500
500
Low
30%
-200
-200
-200
a. Find the NPVs for each of the 3 scenarios (to dollars and cents).
b. Find the expected NPV for the entire project (to dollars and cents).
c. Would you go ahead with this project? Explain your answer.
d. If there is a delay in beginning the project until Year 1, and the Low third scenario (with CFs of negative $200) is not undertaken in Year 1, what is the expected NPV of the modified project (to dollars and cents)?
e. Would you undertake the modified project? Provide your rationale.
Scenario
Probability
Year 1
Year 2
Year 3
High
30%
800
800
800
Average
40%
500
500
500
Low
30%
-200
-200
-200
Explanation / Answer
Since Expected NPV <0, We should NOT go ahead with the project= Answer C)
d) Modified project:
Hence the Expected NPV is > 0
Ae) Yes.. since NPV > 0
` 11.50% High Avg Low Expected Formula 30% 40% 30% 1 Year Cash flow PV of cash flow Cash flow PV of cash flow Cash flow PV of cash flow Cash flow PV of cash flow Cash flow PV of Cash flow 0 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 A A/(1+r)^0 1 800 717.4887892 500 448.4304933 -200 -179.3721973 380 340.8071749 B B/(1+r)^1 2 800 643.4877034 500 402.1798146 -200 -160.8719258 380 305.6566591 C C/(1+r)^2 3 800 577.1190165 500 360.6993853 -200 -144.2797541 380 274.1315328 D D/(1+r)^3 NPV(Answer a) $938.10 $211.31 ($1,484.52) Expected NPV = Answer b) ($79.40) Sum of above PVs of cash flowRelated Questions
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