A firm wants to undertake an investment project which costs $25,000, which it wants to finance through a bank loan. The project has a 60 percent probability of success. If the project succeeds the firm will make a cash flow of $75,000 after a year. If it fails the firm will get a cash flow of $10,000 and will be required to pay the whole amount to the bank. The bank has a required return of 25%.

Question

Calculate the firm's expected profit. Show your workings.