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What is the project's expected NPV?

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Consider the following project data:

(1) A $500 feasibility study will be conducted at t = 0.

(2) If the study indicates potential, the firm will spend $1,000 at t = 1 to build a prototype. The best estimate now is that there is an 80 percent chance that the study will indicate potential, and a 20 percent chance that it will not.

(3) If reaction to the prototype is good, the firm will spend $10,000 to build a production plant at t = 2. The best estimate now is that there is a 60 percent chance that the reaction to the prototype will be good, and a 40 percent chance that it will be poor.

(4) If the plant is built, there is a 50 percent chance of a t = 3 cash inflow of $16,000 and a 50 percent chance of a $13,000 cash inflow.

PLEASE SHOW ALL WORK.

If the appropriate cost of capital is 10 percent, what is the project's expected NPV?

a. -$35

b. -$12

c. $ 0

d. $12

e. $35

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Solution Summary

Calculations for determining net present value are formatted in a table in the attached Excel file. The correct answer is $35.

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  • BE, Bangalore University, India
  • MS, University of Wisconsin-Madison
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  • "Thank you, this helped a lot. I was not sure how to plug in those numbers to a formula. This was a great help. Now I have to figure out how to explain cost of capital is used in net present value analysis, and how cost of capital is used in net present value analysis. This stuff gets confusing."
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