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Taking/Rejecting a Project Based on NPV

1) a) Tropical Sweets is considering a project that will cost $70 million and will generate expected cash flows of $30 million per year for the next three years. The cost of capital for this type of project is 10 percent and the risk free rate is 6 percent. After discussions with the marketing department, you learn that there is a 30 percent chance of high demand, with future cash flows of $45 million per year. There is a 40 percent chance of average demand, with cash flows of $30 million per year. If demand is low (a 30 percent chance), cash flows will be only $15 million per year. What is the expected NPV?

Expected cash flow = (0.3 * 45) + (0.4 * 30) + (0.3 * 15) = 30 million

NPV = -70 + 30/1.1 + 30/(1.1)2 + 30/(1.1)3
NPV = -70 + 27.27 + 24.79 + 22.53
NPV = 4.59
NPV is $ 4.59

My question is: do you think this project should be taken or rejected? And why? I need help understanding this.

Solution Preview

NPV is defined as the difference between an investment's market value and its cost. It is only a good investment if it makes money for the ...

Solution Summary

Solution explains the use of the NPV and guides the reader to a project decision. Reference included.

$2.19