April\'s Stationary and Gift Store is considering two different lines of housewa

Question

April's Stationary and Gift Store is considering two different lines of housewares. The probability distributions of free cash flows in each year associated with the two projects are:
Project A Project B
Probability Outcome Probability Outcome
.25 $4,000 .25 $3,000
.50 $8,000 .50 $6,000
.25 $12,000 .25 $9,000

Both projects will require an initial outlay of $13,000 and will have an estimated life of six years. Project A is considered a riskier investment and will have to have an adjusted required rate of return of 15%, while Project B's required rate of return is 12%.

a. Determine the expected value of each project.

Explanation / Answer

Expected outcome of Project A =.25 *$4,000 +.50 *$8,000 +.25* $12,000=8000 Expected outcome of Project B =.25* $3,000 +.50* $6,000 +.25* $9,000 =6000 NPV of Project A =-$13,000 + 8000/1.15 +8000/1.15^2 +....8000/1.15^6 =$17,275.86 NPV of Project B =-$13,000 + 6000/1.15 +6000/1.15^2 +....6000/1.15^6 =$11,668.44 The expected value of Project A = $17,275.86 The expected value of Project B =$11,668.44

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