An investment project with initial investment of 200,000 dollars at present time

Question

An investment project with initial investment of 200,000 dollars at present time has 35% probability of success and 65% probability of failure. In case of success, project will yield annual income of 55,000 dollars for six years (from first to sixth year) with the salvage value of 100,000 dollars at the end of sixth year. In case of failure, project yield zero income but salvage value of 180,000 dollars at the end of year 2. Considering minimum ROR 12%, 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

Incase the the project is a success:

We can calculate the present value of all the returns using the formula:

A = R* [1-(1+r)^-n]/r

So,

R= $55000

r= 12% =0.12

and n=6

Therefore A= 55000 *[ 1- (1.12) ^ -6]/0.12 = 55000*4.11

A= $ 226127.4

NPV =- Initial Investment+ A + Salvage Value

NPV = -200000 -226127+100000= $126127

Probabilty of which is 35% or 0.35*126127=$44145

And if the project is a failure:

NPV= -Initial Investment+Salvage value= -200000 + 180000

Probablity of failure is 65% or 0.65*-20000= -13000

Therefore NPV of enitire project will be:

Probablity of success (44145) + Pr (-13000) = $31144.5

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