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Net Present Value and Expected Value

Larry's Athletic Lounge is planning an expansion program to increase the sophistication of its exercise equipment. Larry is considering some new equipment priced at $20,000 with an estimated life of five years. Larry is not sure how many members the new equipment will attract, but he estimates his increased yearly cash flows for each of the next five years will have the following probability distribution. Larry's cost of capital is 14%.

(Probability) Cash Flow
.2 $2,400
.4 $4,800
.3 $6,000
.1 $7,200

A) What is the expected value of the cash flow? The value you compute will apply to each of the five years
B) What is the expected net present value?
C) Should Larry buy the new equipment?

Solution Preview

Please find my answer attached in the excel spreadsheet.

A) The expected value will be 4,920 per year ...

Solution Summary

The solution uses the question information to explain the calculations behind expected value and net present value. It uses Excel for computations.