Question
1. You are considering a project with an opportunity cost of 10% and that offers up the following two possible payouts based on your ability
1. You are considering a project with an opportunity cost of 10% and that offers up the following two possible payouts based on your ability to market the product:
In the optimistic state you expect the following payouts, -$4,162, $8,000, $8,000. Based on your pessimistic expectations you expect the following -$4,162, -$500, -$10,000. The cash flows fall at time period 0, 1 and 2.
Your sense is that there is a 40% chance things will turn out well and a 60% chance things will turn out poorly. What is your expected NPV if you are able to abandon the project after year one?
2.
Your firm has an opportunity to invest in a project that costs $800 and you expect it to return two payments of 500 per year. The interest rate of the project is 10%. The current NPV of project is $67.77.
You also have the option to wait one year to invest the $800. If you wait you will know more and can revise your expectations such that you either expect to return two payments of $750 with a probability of 0.5 or alternatively two payments of $300 (the probability of this is equal to 1 minus the probability of the first result). The interest rate of the project is still 10%.
What is the current present value of the NPV if they choose to wait?
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