## Alt investment

danish.hassan7
Good Student
Posts: 10
Joined: Sat Apr 22, 2017 11:51 am

### Alt investment

An investor is considering investing \$5,000,000 in a new project .The expected payoff is \$18,000,000 at the end of five years. The cost of equity for the investor is 10%. Estimated probability of failure at each stage is given by
q23_table5
The investor should most likely:
Choose one answer.
a. Accept the project as it has a positive NPV of \$641,132 Incorrect
b. Accept the project as it has a positive NPV of \$ 614,132 Incorrect
c. Reject the project as it has a negative NPV of \$ 641,132 Correct
The correct answer is C.
The probability that the project will survive for 5 years = ( 1-0.20)x(1-0.15) x(1-0.18)x(1-0.15)x(1-0.2) = 0.39
Present value of payoff from success of the project = -\$5,000,000 + \$18,000,000/(1.1)^5=\$6,176,583.82
Present value of Payoff if the project fails = -\$5,000,000
Net Present Value of the project = 0.39x \$6,176,583.82 -0.61x\$5,000,000= -\$641,132.3

MY QUESTION: kindly explain me the last step of calculating NPV in detail please . and why hey have multiplied the probability of success with the invested amount?

edupristine
Finance Junkie
Posts: 873
Joined: Wed Apr 09, 2014 6:28 am

### Re: Alt investment

We do not know if the project would succeed or not. Hence we are multiplying with the probabilities of both success and failure at the end of five years. (Project surviving probability * value of project if it succeeds) – (project failure probability*value of project if it fails)

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