M Inc asks you to perform a feasibility study of a new video game that requires

Question

M Inc asks you to perform a feasibility study of a new video game that requires an initial investment of $8 million.M Inc. expects a total annual operating cash flow of $1.5 million for the next 10 years. The relevant discount rate is 10 percent. Cash flow occur at year-end.

After one year, the estimate of remaining annul cash flows will be revised wither upward to 2.75 million or downward to $345,000. Each revision has an equal probability of occurring. At that time, the video game project van be sold for $3.1 million. What is the revised NPV given that the firm can abandon the project after one year? Please show the work. Thanks.

$1,986,863.22

$1,971,507.04

$1,216,850.66

None of the above

A.

$1,986,863.22

B.

$1,971,507.04

C.

$1,216,850.66

D.

None of the above

Explanation / Answer

Calculation of NPV

YEAR 1 2 3 4 5 6 7 8 9 10 CIF 1 27,50,000 27,50,000 27,50,000 27,50,000 27,50,000 27,50,000 27,50,000 27,50,000 27,50,000 CIF 2 3,45,000 3,45,000 3,45,000 3,45,000 3,45,000 3,45,000 3,45,000 3,45,000 3,45,000 Expected Cash flow 1547500 1547500 1547500 1547500 1547500 1547500 1547500 1547500 1547500 PV @ 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 5.235 PV of Inflow (A) 1547500 * 5.235 = 81,01,899.41 PV of Salvage (B) 3100000*0.424 = 11,95,184.20 PV OF INFLOW (A + B) 92,97,083.61 PV of OUTFLOW 8000000 * .909 = 72,72,727.27 Revised 20,24,356.34

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