Question

Growth Option: Decision-Tree Analysis

Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $27,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $5,000 per year for 2 years. Fethe's cost of capital is 13%. Do not round intermediate calculations.

1. What is the expected NPV of the project? A negative value should be entered with a negative sign. Round your answer to the nearest dollar.

Answer 1

Expected cash flow in year 1 and 2 = Probability of good demand*cash flow during good demand+Probability of bad demand*cash flow during bad demand

=0.4*27000+0.6*5000=13800

Discount rate	13.000%
Year	0	1	2
Cash flow stream	-20000	13800	13800
Discounting factor	1.000	1.130	1.277
Discounted cash flows project	-20000.000	12212.389	10807.424
NPV = Sum of discounted cash flows
NPV Project =	3019.81
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor