A project has a cost of $50 million. The quality of the project is uncertain. Th

Question

A project has a cost of $50 million. The quality of the project is uncertain. There is a 50% chance that it is a good project and a 50% chance it is a bad project. If the project is good, the cash flow will be $20 million per year for five years. If the project is bad, the cash flow will be $10 million per year for five years. (The first cash flow from the project will occur one year from today.) You will learn whether the project is good or bad, immediately after you invest in it, but not before. The appropriate discount rate for the project is 10%. Assume you cannot cancel the project once you invest. What is the NPV of the project?

A. $6.86 million B. $15.72 million C. $37.91 million D. $56.86 million

Explanation / Answer

Answer: A. $6.86 million

calculation of the NPV of the Project:

NPV=-50 million+0.50(20 million *PVIFA10%,5)+0.50($10 million*PVIFA10%,5)

=-50 million+0.50*(20*3.7908)+0.50(10*3.7908)

=-50+37.908+18.954

=6.86 million

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