Question

Weston Clothing Company is considering manufacturing a new style of shirt with an initial investment cost of $1,000,000. The CFO projects that there is a 20% chance that the shirts will be a hit, resulting in $800,000 incremental cash flows for the next 3 years; a 60% chance that the shirts will be moderately popular, resulting in $520,000 incremental cash flows for the next 3 years; and a 20% chance that the shirts will be a unpopular, resulting in -$200,0000 incremental cash flows for the next 3 years. Assume the project has a 11.5% cost of capital and no salvage value. What is the project's expected NPV?

Answer 1

Are you sure in case of unpopular cash flow is -2million.. (I think it should be 200000 and not 2mil).. can you please check the question again..

please find below solution based on -2mil cash flow in case of unpopular.

rate positively ..

	First we have to compute the expected cash flow
		i	ii	iii=i*ii
	scenario	Cash flow	Probability	Expected cash flow
	Hit	800000	20%	160000
	Moderate	520000	60%	312000
	Unpopular	($2,000,000)	20%	-400000
	Expected annual cash flow			72000
	computation of NPV
		i	ii	iii=i*ii
	year	Cash flow	PVIF @ 11.5%	present value
	0	-1000000	1.0000	(1,000,000)
	1	72000	0.8969	64,574
	2	72000	0.8044	57,914
	3	72000	0.7214	51,941
				(825,571)
	NPV =			(825,571)