A company is considering starting a new line of business. They plan to invest $1

Question

A company is considering starting a new line of business. They plan to invest $1 million in the new business. A recent graduate in Project Management has offered to do a preliminary Expected Monetary Analysis based upon possible outcomes in the first year of operation. There is a probability of .25 that net revenues will be $400,000, .05 probability of net revenues of 2 million, and .70 probability of net revenues of $300,000. What is the expected monetary value of these outcomes in the first year of operation? Should the company proceed with this investment? Explain your recommendation.

Explanation / Answer

Investment = $1 million

P1 =0.25 , E(x1) = 0.4 million

P2=0.05 , E(x2) = 2 million

P3 = 0.70, E(x3) = .3 million

Expected Monetary Value of Outcomes =P1*E(x1) +P2*E(X2)+ P3*E(X3) = $ (0.25*0.4 +.05*2 +0.7*0.3) million = $0.41 Million

if the Company is targeting for breakeven in first year of operation itself, it is not recommended to proceed with this investment as Initial Investment $1 million is more than expected monetary outcomes in first year $0.41 million. To consider for long term returns company has to assess the other years monetary value outcomes also.

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