Question

Exercise - I need the solution written by hand since I have no idea about Excel and we are not allowed to use it in the exam

The Finance department of WC Ltd. has estimated the following net cash flows and probabilities for a new manufacturing process with investments in period 0, net cash flows in periods 1-5 and a potential residual value at the end of period 5:

For P=0.2 the following CFs: -100/20/20/20/20/20/0 (RV)

For P=0.6 the following CFs: -100/30/30/30/30/30/20 (RV)

For P=0.2 the following CFs: -100/40/40/40/40/40/30 (RV)


WC Ltd.'s cost of capital for an average-risk project is 10 percent.

a. Identify the projects expected NPV. Assume that the project has average risk.

b. Identify the best case and worst-case NPVs.

Answer 1

Cost of Capital for an average-risk project = 10 %

Project NPV (Form P = 0.2) = Present Value of Cash Inflow - Cash Present Value of outflow

= (20 * 0.909) + (20 * 0.826) + (20 * 0.751) + (20 * 0.683) + (20 * 0.621) - (100 * 1)

= - 24.20

Project NPV (Form P = 0.6) = Present Value of Cash Inflow - Cash Present Value of outflow

= (30 * 0.909) + (30 * 0.826) + (30 * 0.751) + (30 * 0.683) + (50 * 0.621) - (100 * 1)

= 26.12

Project NPV (Form P = 0.2) = Present Value of Cash Inflow - Cash Present Value of outflow

= (40 * 0.909) + (40 * 0.826) + (40 * 0.751) + (40 * 0.683) + (70 * 0.621) - (100 * 1)

= 70.23

Thus, Projects expected NPV = -24.20 * 0.2 + 26.12 * 0.6 + 70.23 *0.2 = 24.88

Best case is when probability of Project is 0.2 in 3rd case wherein inflows are higher as compared to other cases and worst case is 1st case as inflows are very low which even didn't have positive NPV.