Question

The Z−90 project being considered by Steppingstone Incorporated (SI) has an up-front cost of $250,000. The project's subsequent cash flows are critically dependent on whether another of its products, Z−45, becomes an industry standard. There is a 50% chance that the Z−45 will become the industry standard, in which case the Z−90's expected cash flows will be $110,000 at the end of each of the next 5 years. There is a 50% chance that the Z−45 will not become the industry standard, in which case the Z−90's expected cash flows will be $25,000 at the end of each of the next 5 years. Assume that the cost of capital is 12%. Refer to data for Steppingstone Incorporated. Based on the above information, what is the Z−90's expected net present value? Group of answer choices−$6,678 −$3,251 $15,303 $20,004 $45,965

Answer 1

Answer:

The right solution is Option a (-$6,678).

Explanation:

Given that:

Up-front cost,

= $250,000

Expected cash flows,

= $110,000

Assuming cost of capital,

= 12%

Now,

The expected net present value will be:

= $250000+0.5\times (110000+25000)\times \frac{1}{12 \ percent}\times (1-\frac{1}{1.12^5} )$

= $250000+0.5\times (135000)\times \frac{1}{12 \ percent}\times (1-\frac{1}{1.12^5} )$

= $-6,678$ ($)