What is the project s expected NPV?

QUESTION

Decision Tree. Zoom Technologies, Inc., is considering expanding its operations into digital music devices. Zoom anticipates an initial investment of $1.3 million and, lit best. An optional life of 3 years for the project. Zoom”s management team has considered several probable outcomes over the life of the project. which it has labeled as either “successes” or “failures.” Accordingly, Zoom anticipates that in the first year of operations there is a 65 percent chance of success.” with after cash flow of $800,000. or a 35 percent chance of “failure.” with a meager $1,000 cash flow after tax. If the project “succeeds” in the first year, Zoom expects three probable outcomes regarding net cash flows after tax in the second year. These outcomes are $2.2 million, $1.8 million or $1.5 million. with probabilities of 0.3,0.5, and 0.2. respectively. In the third and final year of operation. the flows cash news after are expected to be either $35,000 more or $55,000 less than they were in Year 2, with an equal chance of occurrence. If On the other hand the project “fails” in Year 1, there is a 60 percent chance that it will produce net cash flows after tax of only $ 1,500 in years 2 and 3. There is also a 40 percent chance that it will really fail and Zoom will earn nothing in Year 2. and will get out of this line of business, terminating the project and resulting in no net cash flows after tax in Year 3.
The opportunity cost of capital for Zoom Technologies is 10 percent.
a. Construct a decision tree representing the possible outcomes.
b. Determine the joint probability of each possible sequence of events.
c. What is the project”s expected NPV?
Solution: Part A Decision tree is constructed based on the different outcomes initiall we have two outcomes that is project failure or success in first year. Probability of failure in first year is 0.35 and 0.65 for success. After year 1 we have 3 possible outcomes in year 2 related to success in year 1and there are two possible outcomes in year 3 associated with each outcome in year 2. where as we if project is failed in first year then we have two outcomes associated with it in year 2 and year 3. Part 2 Year 1 Year 2 Year 3 Joint probabilities Cash flows $ 800,000 $ 2,200,000 $ 2,235,000 Probability 0.65 0.3 0.5 0.0975 Cash flows $ 800,000 $ 2,200,000 $ 2,145,000 Probability 0.65 0.3 0.5 0.0975 Cash flows $ 800,000 $ 1,800,000 $ 1,835,000 Probability 0.65 0.5 0.5 0.1625 Cash flows $ 800,000 $ 1,800,000 $ 1,745,000 Probability 0.65 0.5 0.5 0.1625 Cash flows $ 800,000 $ 1,500,000 $ 1,535,000 Probability 0.65 0.2 0.5 0.065 Cash flows $ 800,000 $ 1,500,000 $

0 Probability 0.65 0.2 0.5 0.065 Cash flows $ 1,000 $ 1,500 $ 1,500 Probability 0.35 0.6 1 0.21 Cash flows $ 800,000 $ 1,500,000 $ 1,455,000 Probability 0.65 0.4 1 0.26 Part 3 Initially expected cash flow associated in year 3 with each out come is found by multiplying cashflows with their associated probabilities and the one year discount rate. In year two both discounted expected cash flows from year 3 and expected cash flows from year 2 are added and further discounted inyear 1 and so on. So finally we recieved expected cast inflows to be $ 2380796 and initial investment is -$ 1300000, which makes NPV of expected cashflows to be $ 1080796.895

ANSWER:

CLICK REQUEST FOR  AN EXPERT SOLUTION