A potential new project would cost $1000 today. The 1st stage of the project wou

Question

A potential new project would cost $1000 today. The 1st stage of the project would last 2 years. There are 2 possible scenarios for Stage 1 net cash flows in years 1 and 2: 1) $801 per year, with 50% probability; or 2) $0 per year, with 50% probability. If the 1st stage outcome is good (with non-zero outcomes), the firm will reinvest an equal amount in year 2 (the same amount invested at year 0) and extend the project into Stage 2 (years 3 and 4). The possible Stage 2 outcomes are either: 1) net cash flows in years 3 and 4 doubling relative to the good Stage 1 outcome (with probability of 50%), or 2) net cash flows of 0 in years 3 and 4 (with probability of 50%). If the Stage 1 outcome is bad, the firm will abandon the project at the conclusion of Stage 1. The cost of capital is 11%. The overall expected NPV of the project (at year 0), considering Stage 1 and the option to expand the project into Stage 2, is $_______.

Explanation / Answer

with explanation:

Year Probability of cash flows Probable cash flows PV F at 11% PV at 11% 0 -1000 1 -1000 1 ((801*50%)+(0*50%))= 400.5 0.90090 360.81 2 ((801*50%)+(0*50%)-(1000*50%)= -99.5 0.81162 -80.76 3 ((801*2*50%)+(0*50%))*50%= 400.5 0.73119 292.84 4 ((801*2*50%)+(0*50%))*50%= 400.5 0.65873 263.82 NPV -163.28

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.