Ch25 P09 Build a Model - 4/19/2010 Chapter 25. Ch 25-9...

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Page 1 4/19/2010 Chapter 25. Ch 25-9 Build a Model a. Find the project's expected cash flows and NPV. WACC= 12% Condition Probability CF CF x Prob. Good 30% $9 Medium 40% $4 Bad 30% -$1 Expected CF= Time line of Expected CF 0 1 2 3 -$10 NPV= Without any real options, reject the project. It has a negative NPV and is quite risky. WACC= 12% Salvage Value = $6 Risk-free rate = 6% Decision Tree Analysis Cost Future Cash Flows NPV this Probability 0 Probability 1 2 3 Scenario x NPV 30% -$10 40% 30% Expected NPV of Future CFs = WACC= 12% Risk-free rate = 6% Decision Tree Analysis Cost Future Operating Cash Flows (Discount at WACC) NPV this 0 Probability 1 2 3 4 5 6 Scenario 30% -$10 40% 30% Expected NPV of Future Operating CFs = Future Cost of Implementing Additional Project (Discount at Risk-free rate) NPV this 0 Probability 1 2 3 4 5 6 Scenario 30% 40% 30% Expected NPV of Future Operating CFs = Total NPV (NPV of Future Operating CF plus NPV of Future Year 3 cost of implenting additional project) = Here the project has a positive expected NPV, so by this criterion it can be accepted. WACC= 12% Risk-free rate = 6% Decision Tree Analysis: Optg. CFs NPV this Probability 0 Probability 1 2 3 4 Scenario x NPV 30% 40% 30% Expected PV of Future CFs = Decision Tree Analysis: Costs Cost NPV this Probability 0 Probability 1 2 3 4 Scenario x NPV 30% 40% 30% Expected PV of Future CFs = Risk-free rate=
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