Question

When your company’s Career Resource Center opens, your research indicates that its Net Present Value has a 60% chance of being $72,000. This NPV considers the present value of a decrease in turnover costs due to the center of $112,000 minus the present value of costs to stock and staff it as and the annual depreciation on the equipment over the project’s term. The present value of all these costs totals $40,000. PV Cash Inflows – PV Cash Outflows = NPV $112,000 - $40,000 = $72,000. But the center also has a 40% chance of barely breaking even with the present value of the reduction of turnover being $42,000 and the present value of costs still the amounts listed above.

1. Given the possible outcomes and their probabilities, what is the expected outcome of the Net Present Value for the Career Resource Center project?

Answer 1

Dear Student,

The concept tested in the question is expected NPV.

Concept of the Expected NPV - Expected net present value is a capital budgeting technique which adjusts for uncertainty by calculating net present values under different scenarios and probability-weighting them to get the most likely NPV.

Formula = Σ (p × Scenario NPV)

where, Scenario NPV is the NPV under a specific scenario while p stands for the probability of occurrence of each scenario.

Scenario	p	NPV	p * NPV
1	0.60	72000	43200
2	0.40	42000-40000=2000	800
		Total	44000

Expected Outcome of NPV = $ 44,000 Answer

Hope you understand the solution.