A project requires investment of 160,000 dollar at year zero. There are 4 possib

Question

A project requires investment of 160,000 dollar at year zero. There are 4 possible outcomes anticipated for this investment: 25% probability of success with annual income of 40,000 dollars for 10 years (starting from year 1 to year 10) and zero salvage value 40% probability of success with annual income of 30,000 dollars for 10 years (starting from year 1 to year 10) and zero salvage value 20% probability of success with annual income of 20,000 dollars for 10 years (starting from year 1 to year 10) and zero salvage value 15% probability of failure with zero annual income and salvage value of 70,000 dollar in the end of year 1. Calculate ENPV, considering minimum ROR 8%, explain if this is a good investment. Explain your work in detail including all the required equations and calculations.

Explanation / Answer

We computed the expected value (EV) for each outcome.

EV1 ($) = 25% x 40,000 x PVIFA(8%, 10) = 10,000 x 6.7101 = 67,101

EV2 ($) = 40% x 30,000 x PVIFA(8%, 10) = 12,000 x 6.7101 = 80,521

EV3 ($) = 20% x 20,000 x PVIFA(8%, 10) = 4,000 x 6.7101 = 26,840

EV4 ($) = 15% x 70,000 x PVIF(8%, 1) = 10,500 x 0.9259 = 9,722

ENPV ($) = Initial investment + EV1 + EV2 + EV3 + EV4

= - 160,000 + 67,101 + 80,521 + 26,840 + 9,722

= 24,184

Since ENPV > 0, this is a good investment.

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