Question

6. You are planning to undertake an investment that costs $17,000 today. Once implemented, you estimate a 0.6 probability that it will do really well and bring in cash flows of $7,000 per year, a 0.3 probability that it will do moderately well and bring in a cash flow of $4,000 per year, and a 0.1 probability that it will limp along and bring in a cash flow of $2,000 a year. The discount rate or the opportunity cost of other investments is 9%. A)What is the expected cash flow? B) The project has a life of 6 years, and at the end of 6 years, you plan to sell your plant and recover $3,000 as salvage value. Find the NPV of the project and state whether the project should be undertaken or not. Show your work clearly.

Answer 1

Requirement A
Expected cash flow
Situation	Cash flow	Probability	Expeceted cash flow
Really well	7000	0.6	4200
Moderately	4000	0.3	1200
limp long	2000	0.1	200
Expected cash flow			5600
Requirement B
Year	PV factor for 9%	Cash flows	Present value of cash flows
0	1.000000	-17000.00	-17000.00
1-6	4.485919	5600.00	25121.15
6	0.596267	3000.00	1788.80
Net present value (NPV)			9909.95
Proejct should be undertaken as it has positive NPV
If we round PV factor further, NPV will slightly change.
PV factors are taken from PV factor tables.