An investment project requires initial investment of 100, 000. There are three p

Question

An investment project requires initial investment of 100, 000. There are three possible outcomes for this project: 5% probability of sucees that investment yields annual income of 40, 000 for eigth years (starting from year 1 to year 8) and zero salvage value 35% probability of sucees that investment yields annual income of 28,000 for eigth years (starting from year 1 to year 8) and zero salvage value 60% probability of failure that yields zero annual income but salvage value of 70, 000 dollar at the end of year 1 Considering minimum ROR 8%, calculate the expected NPV and explain if this investment is satisfactory. Explain your work in detail including all the required equations and calculations.

Explanation / Answer

Initial investment 100000 Years Years Years Years Years Years Years Years Years 0 1 2 3 4 5 6 7 8 Initial cash outflow 100000 Probability - 5% - annula income of 40000 for 8 years 2000 2000 2000 2000 2000 2000 2000 2000 ( calculated by - 5% * 40000) Probability 35% - annual income 28000 for 8 yrs 9800 9800 9800 9800 9800 9800 9800 9800 ( calculated by - 35% *28000) Probability - 60% 0 annula income but salvage at 1st year end 70000 45500 0 0 0 0 0 0 0 100000 57300 11800 11800 11800 11800 11800 11800 11800 PV factor - 8% ROR 1 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 Present value of cash inflows and outflows 100000 53055.5556 10116.59808 9367.220444 8673.35226 8030.88172 7436.0016 6885.186664 6375.1728 Total present value of cash inflows 109939.9692 Present value of cash outflows 100000 NPV = PV of cash inflows - PV of cash outflows 9939.969166 As the NPV of the project is positive , it should be accepted

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