Question

What is the present value of the uncertain payment stream in the table to the right? Time is

measured with the present being 0. P(End) is the probability the payment stream is permanently

terminated before that period’s payment is made, conditional

on the previous period’s payment having been made. So, you

have to work out the probability the venture survives long

enough for each payment to be made. The riskless annual rate

of return is 4%

Time 3 6. 10 P(End) | 0.1 | 0.1 0.4 0.7 -10 -5 Value 60 1000

Answer 1

Discunt rate annual = 4.00% P (End) P (occurance) (occurance) Probability of termination of payment 0.1 0.1 0.4 0.7 Probability that payment will occur =(1-.1) 0.9 =(1-.4) =(1-.7) =1-0.1 0.9 Probability that payment will occur 0.9 0.9 0.6 0.3 | 9 1 Present Value (PV) Duration Timeline 2 3 4 5 8 10 Project 0.00 0.00 0.00 0.00 -10.00 | 0.00 Values 0.00 -5.00 60.00 1000.00 A 10 0.00 0.00 -9.00 0.00 0.00 0.00 | 0.00 300.00 Cash flows 0.00 -4.50 36.00 10 218.47