fm12 13 - 12-10 a. The resulting decision tree is: t=0 t=1...

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Unformatted text preview: 12-10 a. The resulting decision tree is: t=0 t=1 t=2 t=3 P $3,000,000 ($1,000,000) P = 0.80 P = 0.5 1,500,000 ($500,000) NPV NPV Product 0.24 $881,718 $211,612 0.24 (185,952) (44,628) 0.12 (376,709) (45,205) P = 0.5 P = 0.60 100,000 ($10,000) P = 0.20 0 0.40 P = 0.40 1.00 (10,000) (4,000) Exp. NPV = $117,779 The NPV of the top path is: $3,000,000 (1.12) 3 - $1,000,000 (1.12) 2 - $500,000 (1.12)1 - $10,000 = $881,718. Using a financial calculator, input the following: CF0 = -10000, CF1 = -500000, CF2 = -1000000, CF3 = 3000000, and I = 12 to solve for NPV = $881,718.29 ≈ $881,718. The other NPVs were determined in the same manner. If the project is of average risk, it should be accepted because the expected NPV of the total project is positive. b. σ2NPV = 0.24($881,718 - $117,779)2 + 0.24(-$185,952 - $117,779)2 + 0.12(-$376,709 - $117,779)2 + 0.4(-$10,000 - $117,779)2 = 198,078,470,853. σNPV = $445,060. CVNPV = $445,060 = 3.78. $117,779 Since the CV is 3.78 for this project, while the firm’s average project has a CV of 1.0 to 2.0, this project is of high risk. Answers and Solutions: 12 - 13 ...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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