Reworking the NPV for a Project Optimistically and Pessimistically
Not what you're looking for?
Here is a summary of the cash flows for a project which has recently been submitted to a review committee.
Time Period Annual Cash Flow (after taxes)
0 -$1,600,000
1 600,000
2 600,000
3 400,000
4 400,000
Additional information which applies to this investment is:
- The company uses NPV to evaluate all investments.
- The required return on this investment is 15% per year.
- There are actually two possible scenarios for the annual cash flows in years 1-4. Each scenario has a 50% probability associated with it.
- Under the pessimistic scenario, annual cash flows would be $200,000 for years 1 and 2, and $0 for years 3 and 4.
- Under the optimistic scenario, annual cash flows would be $1,000,000 for years 1 and 2, and $800,000 for years 3 and
2. The group presenting this project calculated the weighted average cash flows for each year in developing the numbers in the table above.
- If the project is unsuccessful, the company will have the opportunity to liquidate their investment for ½ its original amount at the end of year two. There is no liquidation value at the end of year 4.
Based on the values in the table above, members of the committee have calculated a NPV of -$130,000. They are talking about rejecting the project. You, however, wonder if this is correct. What alterations, if any, do you recommend in the analysis thus far? Explain.
Purchase this Solution
Solution Summary
The solution summarizes the changes to be made in the response section in 80 words in addition to attaching an spreadsheet with all the possible alternatives' NPVs calculated inside.
Solution Preview
The changes I would make will be to Year 2. The committee ignored the fact that we can liquidate the investment in year 2 and ...
Purchase this Solution
Free BrainMass Quizzes
Motivation
This tests some key elements of major motivation theories.
Marketing Research and Forecasting
The following quiz will assess your ability to identify steps in the marketing research process. Understanding this information will provide fundamental knowledge related to marketing research.
Writing Business Plans
This quiz will test your understanding of how to write good business plans, the usual components of a good plan, purposes, terms, and writing style tips.
Introduction to Finance
This quiz test introductory finance topics.
Income Streams
In our ever changing world, developing secondary income streams is becoming more important. This quiz provides a brief overview of income sources.