An investor estimates that investing €5 million in a particular venture capital project can return $40 million at the end of five years if it succeeds; however, she realizes that the project may fail at any time between now and the end of the fifth year. The investor is considering an equity investment in the project and her cost of equity for a project with this level of risk is 15%. In the table below are the investor’s estimates of certain probabilities of failure for the project. First, 0.30 is the probability of failure in year one. The probability that project fails in the second year, given that it has survived through year one, is 0.25; and so forth:
Year 1 2 3 4 5
Failure Probability 0.30 0.25 0.20 0.20 0.20
a. Determine the expected net present value of the project.
b. Recommend whether the project should be undertaken.