AI question query

CFA Level I Alternative Investments
#1

Good day

Can someone please explain the answer.

heres the question

1.An initial investment of $1mill in a venture capital project is ecpected to pay $10mil at the end of 5 yrs if it is successful. The probabilities of failure for the project are provided below:

Year failure of probability

  • 1 0.3
  • 2 0.25
  • 3 0.2
  • 4 0.2
  • 5 0.2

If the cost of capital for the project is 18%, The projects expected NPV is closest to:

  • A -731 200
  • B 174 950
  • C 906 150

ANSWER = B

I worked out the answer to C

=(-1m + 10m/1.18^5) * 0.2688

Much appreciated

#2

The answer is indeed B.

Your equation is half correct. You will only receive $10 million at a probability of approximately 26.88%. However, it is certain (i.e. 100% probability) that you will spend $1 million if you choose to invest in the project. Therefore, your calculation should be: -

= -1m + [(10m/1.18^5) * 0.2688]

#3

ok, i see where my problem is. It should be (PV*probability) less the initial investment.

thanks, much appreciated