Alt investment

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

Alt investment

Postby danish.hassan7 » Fri Jun 02, 2017 11:00 am

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

Postby edupristine » Wed Jul 19, 2017 3:03 pm

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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