Question

Assume a project costs Sh 30,000 and yields the following uncertain cashflows: Year Cashflow 1 12,000 2 14,000 3 10,000 4 6,000 Assume also that the certainty equivalent coefficients have been estimated as follows: α0 = 1.00 α1 = 0.90 α2 = 0.70 α3 = 0.50 α4 = 0.30 The risk-free discount rate is given as 10% Required Compute the NPV of the project

Answer 1

The Net Present Value (NPV) of the project, based on the given information, is -$2,600.

Step-by-step explanation:

The Net Present Value (NPV) of a project is calculated by discounting the cashflows at the risk-free discount rate and then subtracting the initial cost of the project. To calculate the NPV, we first need to calculate the present value of each cashflow in the project's timeline. The present value is calculated by multiplying each cashflow by its corresponding certainty equivalent coefficient, and then discounting it at the risk-free discount rate of 10%. Finally, we sum up all the present values and subtract the initial cost of the project to get the NPV.

Let's calculate the present value for each cashflow:

• Year 1: $12,000 * 0.90 = $10,800
• Year 2: $14,000 * 0.70 = $9,800
• Year 3: $10,000 * 0.50 = $5,000
• Year 4: $6,000 * 0.30 = $1,800

Next, we calculate the NPV by summing up the present values and subtracting the initial cost of the project:

NPV = $10,800 + $9,800 + $5,000 + $1,800 - $30,000 = -$2,600

Therefore, the NPV of the project is -$2,600.