a) What is the NPV1 if the test result turns out to be successful? b) What is th

Question

a) What is the NPV1 if the test result turns out to be successful?

b) What is the NPV1 if the test result turns out to be unsuccessful?

c) What is the expected value of NPV1?

d) If the company has a discount rate of 16%, what is the NPV0 of the project?

The Quick-Start Company has the following pattern of potential cash flows with their planned investment in a new cold weather system for fuel injected cars. Assume a discount rate of 16%. Invest $120m After-tax Cash Flow: $60m/year Years 2-5 Suptess ot Invest p = 80) Tegt costs $15m IpvestAfter-tax Cash Flow: $10m/year 120m ailure Years 2-5 ot Invest No Test

Explanation / Answer

a) If the test turns out to be successful Present value of annuity(60000000) for 4 years - 120000000 Present value of annuity(60000000) for 4 years $167,890,838.29 NPV(16%,60000000,60000000,60000000,60000000) -120000000 $47,890,838.29 Answer NPV1 47890838.29 b) If the test turns out to be unsucessful Present value of annuity(10000000) for 4 years - 120000000 $27,981,806.38 -120000000 -92,018,193.62 Answer NPV1 -92018193.62 c) expected value of NPV1 we multiply each NPV by its probabilities and then add 0.80 * 47890838.29 + 0.20* -92018193.62 = 19909031.91 Answer expected value of NPV1 19909031.91 d) NPV0 = discounted expected value of NPV1 - 15000000 ( the initial cost of the test) $17,162,958.55 - 15000000 $2,162,958.55 Answer

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