A company is considering a new product that would require an investment of $10 m

Question

A company is considering a new product that would require an investment of $10 million now, at t = 0. There is a probability of 30% that the new product will be very well received, then the project would produce after-tax cash flows of $7 million at the end of each of the next 3 years (t = 1, 2, 3); there is a probability of 40% that the product will have an average market, in that case the project would produce after tax cash flows of $3 million at the end of each year for the next 3 years. Finally, there is a probability of 30% that the market will not like the product then the cash flows would be only $1.5 million per year.

The project's WACC is 10.0%.

What is the expected NPV of this project?

-$469,512.61

-$674,305.03

-$785,287.12

-$954,217.39

-$301,277.24

Explanation / Answer

Correct answer is -$674,305.03

Working Note:

In this problem, firstly we will calculate the expected cash flow through probabilities.

Expected cash flow per year = Probability1*cashflow1 + Probability2*cashflow2 + Probability3*cashflow3

                                                         =.3*7 million + .4*3 million +.3*1.5 million

                                           = 3.75 million

So NPV = Present value of cash inflows - investments

            =3.75 million*(1-1/1.1^3)/.1    - 10 million

             = 9.3256 Million - 10 million

             NPV= - $674305.03

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