Question

Complete the decision tree table by calculating the net present values (NPVS) and joint probabilities, as well as products of joint probabilities and NPVS for each decision branch. Assume that the weighted average cost of capital (WACC) is 10% for all decision branches. Hint: Use either a spreadsheet program's functions or a financial calculator for this task. Round the NPVS to the nearest dollar and remember to enter the minus sign if a value is negative Note: All cash amounts in the following table are in thousands of dollars. Step 1 Step 2 Step 3 Step 5 Step 0 Step 4 NPV x Joint Prob ($) Prob 2nd Prob 3rd Inflow Inflow Inflow NPV ($) Joint Prob 1st Invest Invest (%) Invest (2) 50% (3) $4,761 $8,237 $20,065 $10,269 (2) 40% (3) $1,900 85% -$100 $2,345 $7,800 - $10,000 (1) (2) 10% (3) $0 Stop $0 $0 $20 15% Stop $0 $0 $0 Expected NPV Based on your calculations, you recommend that Purple Turtle Group

(discontinues all old products and switches to igadgets, accepts the new project, rejects the new project, delays the new project)

Answer 1

Net present value of investment decision is calculated as:

=Present value of inflows - Present value of outflows

Excel spreadsheet is used to calculate the NPV for the investment in 3rd step.

The snip shot of the calculation is enclosed below for reference

The present value of first cash inflow in step4 =

CASH INFLOW IN FIRST YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 4761 10% 0.909090909 4328.181818

The present value of second cash inflow in step5=

CASH INFLOW IN SECOND YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 6807.438017 10% 8237 0.826446281

The present value of third cash inflow in step5=

CASH INFLOW IN THIRD YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 10% 15075.13148 20065 0.751314801

Therefore, the net present value of investment decision in step3=

TOTAL PRESENT VALUE OF INFLOWS 26210.75131 TOTAL PRESENT VALUE OF OUTFLOws 10269 15941.75131 NET PRESENT VALUE

Therefore, the joint probability =probability that investment in step3= 0.50

Therefore, The NPV * joint probability = 0.50 * 15941.75131 = $7970.875

b.)

The present value in step4 for investment decision2=

CASH INFLOW IN FIRST YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 10% 1900 0.909090909 1727.272727

The present value in step5 for investment decision2=

CASH INFLOW IN SECOND YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 10% 2345 0.826446281 1938.016529

The present value in step6 for investment decision2=

CASH INFLOW IN THIRD YEAR WACC DISCOUNT FACTOR PRESENT VALUE OF INFLOW 10% 7800 0.751314801 5860,255447

Therefore, the net present value of investment decision2=

TOTAL PRESENTVALUE OF INFLOWS 9525.544703 10000 PRESENT VALUE OF OUTFLOW IN STEP2 PRESENT VALUE OF OUTFLOW IN STEP3 100 NET PRESENT VALUE 574.4552968

joint probability= probability of investment in step2 * probability of investment in step3

=.85*.40= 0.34

NPV * joint probability = -574.4553 * 0.34 = -$195. 3148

c.) the net present value in step0 for ist investment =$-20*0.10 =-$2

Therefore, the total expected net present value=

7970.875 -195.3148 NPV from Ist decision NPV from 2nd decision NPV from 3rd decision -2 |-c20+C21+C22 Total Expected NPV

=

NPV from Ist decision 7970.875 NPV from 2nd decision -195.3148 NPV from 3rd decision -2 Total Expected NPV 7773.5602

Therefore, The expected net present value=$7773.5602