Question

(14 points) Sega, Inc. is considering expanding its operations into computer-based lacrosse games. Sega feels that there is a 3-year life associated with the project, and it will initially involve an investment of $100,000. It also believes that there is a 60% chance of success and a cash flow of $100,000 in year 1 and a 40% chance of failure and a $10,000 cash flow in year 1. If the project fails in year 1, there is a 60% chance that it will produce cash flows of only $10,000 in years 2 and 3. There is also a 40% chance that it will really fail and Sega will earn nothing in year 2 and get out of this line of business, with the project terminating and no cash flow occurring in year 3. If conversely, this project succeeds in the first year, then cash flows in the second year are expected to be $200,000, $175,000 or $150,000 with probabilities of 30%, 50%, and 20%, respectively. Finally, the cash flows in the third and final year of operation are expected to be either $30,000 more or $20,000 less than they were in year 2, with an equal chance of occurrence. 4. (4 points) Construct the decision tree representing the possible outcomes. a. (3 points) Determine the joint probability of each possible sequence of events. Show your work. (2 points) Determine the IRR of each possible sequence of events. d. b. c. (2 points) What is the expected IRR for this project? Show your work. (3 points) What is the standard deviation of the IRR for this project? Show your work. e.

Answer 1

Please refer the image for part a and part b

Probabclt 21-1 sob $ 230,006-9 % $ 200,000くsote、手1 80,006ー 9 % 9911 130 50 1a5 小? $10, 0067504事175,000 Sef 4 165,000 116/ 00, 000 104 esl> $10,000 っ$10,000 -421. TRR16/>L3o5D t (?1.xl»)+(87 x12.1) t Ct5% x11 Expecte4 6x1 니6.9%

c) Note: IRR can be found by excel function or financial calculator

	0	1	2	3	IRR	Probability	Square of deviation from mean
1	-100	100	200	230	130%	9%	0.1436
2	-100	100	200	180	125%	9%	0.1436
3	-100	100	175	205	121%	15%	0.1018
4	-100	100	175	165	116%	15%	0.1018
5	-100	100	150	180	111%	6%	0.1673
6	-100	100	150	130	104%	6%	0.1673
7	-100	10	10	10	-42%	24%	0.0524
8	-100	10	0	0	-90%	16%	0.0955
						MEAN	Standard deviation
						46.9%	32.30%

c) Expected IRR is the weighted average of all the IRRS. Weights here are the corresponding probabilities.

Expected IRR = 46.9%

d) Standard deviation is the weighted average of the IRRs from expected IRR