Question

We are examining a new project. We expect the project to generate cash flow of 5,000 over the next 7 years. However, we also expect to find out if the project is a success or failure. If it is a success, it will produce the cash flow of  $11,000 per year, while i it is a failure, the cash flow will be only $1,000 per year. The project can be abandoned in one year, and in that case, the sale of the assets tied up in the project is expected to generate the cash flow of $15,000. Find the NPV of the project if the applicable discount rate is 14% and the probability of success is 40%

Answer 1

1]	NPV if, the project is a success = 11000*(1.14^7-1)/(0.14*1.14^7) =	$               21,442
2]	NPV if, the project is not a success = 16000/1.14 =	$               14,035
3]	Expected NPV = 21442*40%+14035*60% =	$               16,998