At stage 2 of the decision tree it shows that if a project is successful,the payoff will be $53,000 with a 2/3 chance of occurrence. There is also the 1/3 chance of a $-24,000 payoff. The cost of getting to stage 2 (1 year out) is $44,000. The cost of capital is 15%. What is the NPV of the project at stage 1?
A) $-13,275
B) $-20,232
C) $2,087
D) $7,536
E) Cannot be calculated without the exact timing of future cash flows

Question

Quizplus · Accepted Answer

To calculate the NPV at stage 1, we need to discount the expected cash flows from stage 2 back to stage 1:

Expected cash flow at stage 2 = (2/3)($53,000) + (1/3)($-24,000) = $34,333

PV of expected cash flow at stage 2 = $34,333 / (1 + 0.15) = $29,836.52

NPV at stage 1 = -$44,000 + $29,836.52 = -$14,163.48

Therefore, the answer is B because the NPV at stage 1 is negative, indicating that the project should not be pursued.

At Stage 2 of the Decision Tree It Shows That