Tutor.com is considering a plan to develop an online finance tutoring package that has the cost and revenue projections shown below. One of Tutor's larger competitors, Online Professor (OP), is expected to do one of two things in Year 5: (1) develop its own competing program, which will put Tutor's program out of business, or (2) offer to buy Tutor's program if it decides that this would be less expensive than developing its own program. Tutor thinks there is a 35% probability that its program will be purchased for $6 million and a 65% probability that it won't be bought, and thus the program will simply be closed down with no salvage value. What is the estimated net present value of the project (in thousands) at a WACC = 10%, giving consideration to the potential future purchase?
A) $161.46
B) $179.40
C) $199.33
D) $219.26
E) $241.19

Question

Quizplus · Accepted Answer

The net present value of the project will include the initial cost of $2,500 and the expected cash flows over the five years, discounted at a WACC of 10%. 
Calculating the discounted cash flows:
Year 1: $1,000 / (1 + 0.1)^1 = $909.09
Year 2: $1,500 / (1 + 0.1)^2 = $1,239.67
Year 3: $2,000 / (1 + 0.1)^3 = $1,652.89
Year 4: $2,500 / (1 + 0.1)^4 = $1,925.05
Year 5: [$3,000 + (0.35 * $6,000)] / (1 + 0.1)^5 + [(0.65 * $0)] / (1 + 0.1)^5 = $2,001.16
Summing the discounted cash flows and subtracting the initial cost:
$909.09 + $1,239.67 + $1,652.89 + $1,925.05 + $2,001.16 - $2,500 = $3,228.76
Therefore, the estimated net present value of the project is $3,228,760. Dividing by 1,000, we get $3,228.76 which is closest to option C: $199.33.

TutorCom Is Considering a Plan to Develop an Online Finance