The analyst estimates the probability that the project will fail in the first year as well as conditional probability of failure for each of the remaining four years of the project, as follows: Year: 1 2 3 4 5 Failure Probability 0.25 0.20 0.20 0.15 0.10 The project will have no payoff if it fails, but will have a payoff of $20,000 at the end of the fifth year if it succeeds. Because of its high risk, the required rate of return for an investment in this project is 25%. Based on this info, the expected value of the project is closest to: A. $2,400 B. 3,010 C. 5,900 D 6,550 I do not understand how to solve this… Please, help!
probability of success of project = .75 * .8 * .8 * .85 * .9 = .3672 (If project fails in any intervening year, it has failed) Payoff on success at end of 5th year = .3672 * 20000 = 7344 So PV now = 7344 / 1.25^5 = 2406 Ans A
Thanks a lot! I got it. )))