Question

As CEO of Internet Boon Ventures, you are considering putting together a new vacation travel internet planning site. If you put together the site and it is highly successful, you believe the site would generate $8 million in the present value of cash flows. If you put it together but it is not successful, you believe the site would generate only $1 million in present value cash flows. You believe there is a 45% probability that the site would be highly successful, and your costs of creating and maintain the site are $3 million. Which of the below best describes the expected value of this project?

		Less than or equal to zero.
		Greater than 0, less than $500,000.
		Greater than or equal to $500,000, less than $1,000,000.
		Greater than or equal to $1,000,000, less than $1,500,000.
		Greater than or equal to $1,500,000

Answer 1

Given,

Cost of creating and maintaining the site = $3 Million

Present value of cash flows if highly successful= $8 Million

Therefore, PV of net cash flows if highly successful (C1)= $8 Million-$3 Million= $5 Million

Probability of being highly successful (P1)= 45%

Present value of cash flows if not successful= $1 Million

Therefore, PV of net cash flows if highly successful (C2)= $1 Million-$3 Million= -$2 Million

Probability of being highly successful (P2)= (1-45%)= 55%

Expected value of the projects= C1*P1 + C2*P2

=$5 Million*0.45 + -$2 Million*0.55 = $2.25 Million - $1.1 Million = $1.15 Million

Hence the answer is 4^th choice,

‘Greater than or equal to $1,000,000, less than $1,500,000’.