An investor gathered following info about a venture capital project: Initial investment in project: $40000 Est. payoff if project is successful: $12 million Time to payoff for project: 8 years Probability of project’s survival until end of year 8: 15% Investor’s required rate of return: 17% The NPV of the venture capital project is closest to: A. $52608 B. $112608 C. $172608 D. $452608 Ans. is 112608 …whereas I get 172608…Can anybody explain pls. This is on cfa pg244 in Alt. investments.
I think you dropped a “0” off of the initial investment outlay… CFo = -400,000 C1 = 0 F1 = 7 C2 = .15*12M = 1.8 M F2 = 1 I = 17 CPT NPV = 112,608
yeah … you are correct abt the ‘0’ …it should be $400,000 Now abt the solution, shouldnt we consider a probability weighted npv? FV=12mil N=8 I/Y=17 CPT PV=3,417,388 Net NPV=0.15(3,417,388)+0.85(-400,000) = 172,608 I see an another question solved on page 206 using weighted probability of success and failure of project!
Had a problem with same question today… Took me a while but eventually figured it out… The NPV if it is a success is not 3,417,388 but it is 3,017,388 (3,417,388 - 400,000 inital investment)… Therefore NPV is probability of success (15% * 3,017,388) plus probability of failure (85% * -400,000) = 112,608 Hope this helps…
Oh thanks a ton! You dont know how much I appreciate it! Else I was starting to get panicky abt the concepts…