Napier Kowloon Ltd is a computer games company serving the Hong Kong market. A new game has been developed and market research has shown that the game has an estimated life of 2 years. The following data is available. The game will require an initial investment of $80 million dollars in year 0. In year 1 of the project the net cash inflows if sales are High will be $70 million. If sales are Low the net cash flow will be $40 million. The probability of each outcome in year 1 is High 60% and Low 40%. In year 2 if the sales in year 1 are High there is a 70% probability that cash inflows will be $90 million and a 30% probability that cash inflows will be $60 million. If the sales in year are Low there is a 60% probability that cash inflows will be $30 million and a 40% probability that cash inflows will be $20 million.

The above can be summarised as follows: Year 1 Probability Year 2 Probability

Sales Sales Cash Flows Cash Flows $million $million

High 70 40% 90 70%

60 30%

Medium 55 40% 70 75%

45 25%

Low 40 20% 30 60%

20 40%

The company has a cost of capital of 12%. Required: a) Using these FOUR possible outcomes calculate the expected net present value of the project. (Calculations should be done in millions to two places of decimals). What is meant by the expected NPV of a project? (15 marks) b) What is the probability of an outcome being within: i) 0.5 of a standard deviation from the expected outcome ii) 1.5 of a standard deviation from the expected outcome Calculate the variance and the standard deviation of the above project. What does this tell us about the project? (8 marks) c) Calculate the Z score for the project, using the expected net present value and standard deviation you have calculated. (3 marks) d) The board of Napier Kowloon Ltd have a policy of not undertaking projects which have more than a 25% chance of returning a negative net present value. Should the project in above be undertaken? Advise the board giving reasons. (4 marks) e) Expected values and probability analysis is one approach to assessing the risk of projects in the investment appraisal process. Evaluate one other method comparing its use to the techniques above.