Consider the case of Hack Wellington Co. Hack Wellington Co. is considering a th
ID: 2742962 • Letter: C
Question
Consider the case of Hack Wellington Co. Hack Wellington Co. is considering a three year project that will require an initial investment of $35,000. It has estimated that the annual cash flows for the project under good conditions will be $40,000 and $10,000 under bad conditions. The firm beleives that there is a 60% chance of good conditions and a 40% chance of bad conditions. If the firm is using the weighted average cost of capital of 13%, the expected net present value of the project is? a. 18,667 b. 117,112 c. 34,223 d. 31,112 Hack Wellington Co. wants to take a potential growth option into account when calculating the project's expected NPV. If conditions are good, the firm iwll be able to invest $5,000 in year 2 to generate an additional cash flow of $18,000 in year year. If condiditons are bad, the firm iwll not make any further investments in teh project. Using the infomation from the preceding problem, teh expected NPV of the is project-when taking the grwoth option into account-is ? a. 36,248 b. 34,436 c. 43,498 d. 32,623 Hack Wellington Co.'s growth option is worth? a. 5,393 b. 5,136 c. 5,906 d. 4,109 e. 4,366 Someone helped me with the first part, with its solution being 31,112. I'm having problems trying to understand this series, please help me with the second and third part. Thank you
Explanation / Answer
Answer 1.
Initial Investment = $35,000
Chances of Good Conditions and Bad Conditions are 60% and 40% respectively.
Annual Cash Flow in Good conditions is $40,000
Annual Cash Flow in Bad conditions is $10,000
NPV under Good Condition = -35,000 + 40,000*PVIFA(13%, 3)
NPV under Good Condition = $59,446.10
NPV under Bad Condition = -35,000 + 10,000*PVIFA(13%, 3)
NPV under Bad Condition = $ -11,388.47
Expected NPV = 60%*59,446.10 + 40%*(-11,388.47)
Expected NPV = $31,112
Answer 2.
Initial Investment = $35,000
Chances of Good Conditions and Bad Conditions are 60% and 40% respectively.
Growth option require an additional investment of $5,000 in year 2 which will provide an additional cash flow of $18,000 in year 3.
NPV under Good Condition = -35,000 + 40,000/1.13 – 5,000/1.13^2 + 40,000/1.13^2 + 58,000/1.13^3
NPV under Good Condition = $68,005.27
NPV under Bad Condition = -35,000 + 10,000*PVIFA(13%, 3)
NPV under Bad Condition = $ -11,388.47
Expected NPV = 60%*68,005.27 + 40%*(-11,388.47)
Expected NPV = $36,247
Answer 3.
Worth = 36,247 – 31,112
Worth = $5,136