## Q. 3.PP.41

A company has made the following estimates of the CFAT associated with an investment proposal.
The company intends to use a decision tree to get a clearer picture of the project’s cash inflows. The project has an expected life of 2 years.
The equipment costs Rs 40,000 and the company uses a 10 per cent discount rate for this type of investment.
$\,$   (i) Construct a decision tree for the proposed investment project.
$\,$  (ii) What NPV will the project yield if the worst outcome is realised? What is the probability of
$\,$       occurrence of this NPV?
$\,$ (iii) What will be the NPV if the best outcome occurs? What is its probability?
$\,$ (iv) Will the project be accepted?

 $Probability$ $CFAT\> (t = 1)$ 0.4 Rs 25,000 0.6 30,000 CFAT (t = 1) 0.2 If CFAT$_1$ = Rs 25,000 … Rs 12,000 0.3 16,000 0.5 22,000 0.4 If CFAT$_2$ = Rs 30,000 …      20,000 0.5 25,000 0.1 30,000

## Verified Solution

$\,$  (ii) If the worst outcome is realised, the NPV of the project would be (Rs
$\,$         7,363).
$\,$ (iii) If the best outcome, the NPV of the project would be Rs 12,050. There
$\,$       is a 6 per cent probability of this outcome.
$\,$ (iv) Yes, the project should be accepted, as the project is expected to
$\,$       yield a positive NPV of Rs 3,111.88.