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A firm is considering investing $10 million today to start a new product line. The future...

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Finance

A firm is considering investing $10 million today to start a newproduct line. The future of the project is unclear however anddepends on the state of the economy. The project will last 5 years.The yearly cash flows for the project are shown below for thedifferent states of the economy. What is the expected NPV for theproject if the cost of capital is 12%? (Show your work. Label $. Nodecimal places required. Highlight or bold your answer.)

Project

Chance of

Yearly

Outcome

Outcome

Cash Flow

GOOD

25%

$8,000,000

AVERAGE

50%

$3,000,000

BAD

25%

($2,000,000)

Answer & Explanation Solved by verified expert
4.2 Ratings (764 Votes)

Step-1:Calculation of expected annual cash flow
Project outcome Chance of outcome Yearly cash flow
a b c=b*a
GOOD 25% $         80,00,000 $ 20,00,000
AVERAGE 50% $         30,00,000 $ 15,00,000
BAD 25% $       -20,00,000 $ -5,00,000
Total Expected cash flow $ 30,00,000
Step-2:Calculation of expected NPV
Expected present value of annual cash flow $         30,00,000 * 3.604776 = $       1,08,14,329
Less cost of project $       1,00,00,000
Expected NPV $             8,14,329
Working:
Present value of annuity of 1 = (1-(1+i)^-n)/i Where,
= (1-(1+0.12)^-5)/0.12 i 12%
= 3.604776202 n 5
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