Question

Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.

The NPV for this project is closest to:
A) $6,250
B) $14,100
C) $10,000
D) $18,600

Answer 1

Answer:

The NPV for the project will be $6000 which is not in the given option

Explanation:

We have given the project has free cash flows in one year of $90,000 in a weak economy

Project cash flow at the end of year 1 in weak economy = $C_{1weak}$  $ 90,000

Cash flows to lenders, $C_L$ = FV of debt = Debt x (1 + interest rate) = 80,000 x (1 + 0.05) = $ 84,000

Hence cash flows to equity holders = $C_{1weak}$ - $C_L$ = 90,000 - 84,000 = $ 6,000

So the NPV for the project will be $6000 which is not in the given option