Ernst is analyzing a project and has determined that the initial cost will be $423,000 and the required rate of return needs to be 16 percent.The project has a 2 percent chance of success and a 98 percent chance of failure.If the project fails,it will generate an annual cash flow of -$131,000.If the project succeeds,the annual cash flow will be $789,000.He has further determined that if the project is a failure,he can shut it down after the first two years but will not be able to recover any of his investment.If however,the project is a success,he can expand it after the second year with no additional investment and increase the cash flow to $1,020,000 a year for Years 3 and 4.At the end of Year 4,the project would be terminated and have no salvage value.What is the net present value of this project at Time 0?

Question

Quizplus · Accepted Answer

PV Success inflows = $789,000/1.16 + $789,000/1.16² + $1,020,000/1.16³ + $1,020,000/1.16⁴ = $2,483,335.69PV Failure inflows = -$131,000/1.16 + (-$131,000/1.16²)= -$210,285.37NPV₀ = -$423,000 + .02 × $2,483,335.69 + .98 × -$210,285.37 = -$579,412.95

Ernst Is Analyzing a Project and Has Determined That the Initial