Heywood Diagnostic Enterprises is evaluating a project with the following net cash flows and
probabilities:
Year Prob=0.2 Prob=0.6 Prob=0.2
0 -$100,000 -$100,000 -$100,000
1 $20,000 $30,000 $40,000
2 $20,000 $30,000 $40,000
3 $20,000 $30,000 $40,000
4 $20,000 $30,000 $40,000
5 $30,000 $40,000 $50,000
The Year 5 values include salvage value. Heywood's corporate cost of capital is 10 percent.
a. What is the project's expected (i.e., base case) NPV assuming average risk? (Hint: The base case net cash flows are the expected cash flows in each year.)
b. What are the project's most likely, worst, and best case NPVs?
c. What is the project's expected NPV on the basis of the scenario analysis?
d. What is the project's standard deviation of NPV?
e. Assume that Heywood's managers judge the project to have higher-than-average risk. Furthermore, the company's policy is to adjust the corporate cost of capital up or down by 3 percentage points to account for differential risk. Is the project financially attractive?