Scenario: Using the situation from SLP2, recall that you are deciding between tw

Question

Scenario: Using the situation from SLP2, recall that you are deciding between two investments. However, they each require a different initial investment amount. And you also have a third option, to invest in a 10 year municipal bond with a very high return. Here are the investment options with the augmented data. Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. Required initial investment: $0.75 million High NPV: $5 million, Pr = 0.5 Medium NPV: $2 million, Pr = 0.3 Low NPV: $0, Pr = 0.2 Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities. Required initial investment: $0.55 million High NPV: $3 million, Pr = 0.75 Medium NPV: $2 million, Pr = 0.15 Low NPV: $1 million, Pr = 0.1 Option C: High Yield Municipal Bonds. This option has low risk and is assumed to be a Certainty. So there is only one outcome with probability of 1.0 Required initial investment: $0.75 million NPV: $1.5 million, Pr = 1.0

Explanation / Answer

Based on Above NPV, the Opion "A" is better and should go ahead for that option

Schedule of comparison of Investment Option-Amount in Million $ Option A Option B Option C High NPV A                        5.00 3.00 Probabilty B                        0.50 0.75 Medium NPV C                        2.00 2.00 Probabilty D                        0.30 0.15 Low NPV E                             -   1.00 Probabilty F                        0.20 0.10 Expected NPV (A*B)+(C*D)+(E*F)                        3.10 2.65 1.50

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