Question

you can acquire an existing business for $2 million. You are uncertain about future demand. There is a 40% chance of high demand, in which case the present value of the business will be $3 million. There is a 25% chance of moderate demand, and the associated present value is $1.5 million. Finally, there is a 35% chance of low demand, in which case the present value is $1 million. Draw a decision tree for this problem. What is the expected net present value of the business

Answer 1

Expected net present value of the project = $1,925,000

Step-by-step explanation:

The cost of acquiring business = $2,000,000

Expected net present value of the project = High demand NPV*High demand percent + Moderate demand NPV*Moderate demand percent + Low demand NPV*Low demand percent

Expected net present value of the project = $3,000,000 *40% + $1,500,000*25% + $1,000,000*35%

Expected net present value of the project = $1,200,000 + $375,000 + $350,000

Expected net present value of the project = $1,925,000

Conclusion: The cost of acquiring business is more than expected net present value, it is advisable not to invest in the project.