Ms. Lee Ding is considering whether the following capitol project should be unde
ID: 2748209 • Letter: M
Question
Ms. Lee Ding is considering whether the following capitol project should be undertaken. Its life is 6 years; it has a 6% salvage value; and her firm uses a 12% MARR.
Initial Cost P* Annual Net Revenue P*
$250,000 0.4 $ 75,000 0.2
300,000 80,000
350,000 0.2 90,000 0.2
400,000 .05 100,000 0.1
500,000 .05 115,000 0.1
What is the probability of it costing $300,000?
What is the probability of the net revenue being $80,000?
What is the expected value of the project?
Should she do it?
Explanation / Answer
(1) Let p be the required probability.
Then p' = 1 - p , or p = 1 - p'
p' = 0.4+0.2+0.05+0.05 = 0.7
Therefore p = 1 - 0.7 = 0.3
So probability of projecting costing $ 300,000 = 0.3
(2) Let p be the required probability.
p' = 0.2+0.2+0.1+0.1 = 0.6
Therefore p = 1 - 0.6 = 0.4
So probability of projecting costing $ 80,000 = 0.4
(3) Expected Value of the Project is calculated as below
Expected Cost = (250000*0.4+300000*0.3+350000*0.2+400000*0.05+500000*0.05) = 305000
Expected Annual Revenue = (75000*0.2+80000*0.4+90000*0.2+100000*0.1+115000*0.1) = 86500
Expected Value of the Project = 59,908
As the NPV of the project is positive, so she should do it.
Expected Cash Flow Year Cost Income Discount Cash Flow 0 (305,000) 1 86,500 77,232 2 86,500 68,957 3 86,500 61,569 4 86,500 54,972 5 86,500 49,082 6 104,800 53,095 Total (305,000) 364,908 NOTE: 6th year Income includes Revenue + 6% Salvage NPV = 59,908Related Questions
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