CFA Practice Question

There are 139 practice questions for this study session.

CFA Practice Question

A venture capital project has the following estimated probabilities of failure over the next five years.
Year 1 2 3 4 5
Prob 10% 25% 30% 10% 10%

If it "survives", the payoff is expected to be $80 million. The initial investment required is $20 million. If the risk-adjusted discount rate is 20%, what is the project's expected NPV? (Round to the nearest $100,000)
A. -$7.1 million.
B. -$7.7 million.
C. -$8.5 million.
Explanation: The probability of success equals the probability that the investment "survives" until the end of the fifth year:
Probability of success = 0.90 x 0.75 x 0.70 x 0.90 x 0.90 = 0.3827
Expected payoff = $80,000,000 x 0.3827 = $30,616,000
Discounted payoff = $30,616,000/(1.20)5 = $12,303,884
NPV = $12,303,884 - $20,000,000 = -$7,696,116

User Contributed Comments 5

User Comment
jgraham6 good question
dini85 if probability of success is taken into consideration... why probability of failure is ignored...

Can someone explain..
Skrills it's not that it's ignored, you use probablity of success to solve, and in question they gave you prob of failure to add extra work
leftcoast But, doesn't -$20,000,000 have to be multiplied by the probability of failure?
abellochs You pay 20 mnl regardless of the outcome so you don't need to adjust it. 80mln payoff depends on the success of the project.
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