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Investment appraisal under uncertainty

Question 4

EVs in NPV calculation

A project requires an investment of $50,000 today and will bring in annual sales
volumes for 3 years of 5,000 units with annual operating costs of $20,000. The
asset will have no value at the end of the project.

The sales price has not yet been finalised due to uncertainty in the market. A
probability analysis has been put together as follows:

20% probability of selling at $10 per unit, 30% of $9 per unit and 50% of $8 per
unit.

There is no tax or inflation. The discount rate is 10%.

Calculate the NPV of the project.

Expected sales price = 0.2 × $10 + 0.3 × $9 + 0.5 × $8 = $8.70

Expected revenue = $8.70 × 5,000 = $43,500

df/af 10% PV
t0 purchase (50,000) 1 (50,000)

t1-3 revenue 43,500 2.487 108,185
t1-3 operating costs (20,000) 2.487 (49,740)

NPV 8,445

Illustrations and further practice

Now try TYU questions 3 and 4 from Chapter 6

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