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In the BPP book they have described probability as a really big thing, with finding joint probabilities with huge tables (almost 15 20 min to find out the EV) and so on….but in your lecture you mentioned only simple expected values which was ridiculously easy.. i was wondering if those huge table could come up in the exam? or just knowing how to calculate simple EV would do it?
In F9, the only time the examiner has asked for more than a simple expected value was Question 1 of the June 2010 exam. Even then it was not particularly complicated and the chances of him asking for any more than that are remote.
Well Q1 of June 2010 is effectively an exercise on simulation.
I cannot believe there would ever be more than that (and more likely anyway as a small written part of a question – but that question is quite good because if you understand it, then it makes it easier to write about simulation.)Hi
I am studying F9 BPP book and I really can not understand how they calculate expected value (under probability analysis) Could please tell me where i can learn the easy method for this?
CK
Hi ,
Could you please any one can give me the easy method to calculate EV for following question? if there is a lecture relate to this please give me the link.
A company is considering a project involving the outlay $300,000 which it estimates will generate cash flows over its two year life at the probability shown in the following table
year 1 Cashflow Probability
100,000 0.25
200,000 0.50
300,000 0.25year 2
if cash flow in year1 is 100,000
– there is probability of 0.25 – that the cash flow in year 2 will be nill
– there is probability of 0.50 – that the cash flow in year 2 will be 100,000
– there is probability of 0.25 – that the cash flow in year 2 will be 200,000if cash flow in year1 is 200,000
– there is probability of 0.25 – that the cash flow in year 2 will be 100,000
– there is probability of 0.50 – that the cash flow in year 2 will be 200,000
– there is probability of 0.25 – that the cash flow in year 2 will be 300,000if cash flow in year1 is 300,000
– there is probability of 0.25 – that the cash flow in year 2 will be 200,000
– there is probability of 0.50 – that the cash flow in year 2 will be 300,000
– there is probability of 0.25 – that the cash flow in year 2 will be 350,000Company cost of capital 10%
you are required to calculate the EV of project’s NPV and the probability that the NPV will be negative
Thank you so much
CK
This is an example needing joint probabilities, and if he does ask a question needing them then there is no way he will make it bigger.
I will start you off and explain what I am doing. However because it then becomes very repetitive (keep doing the same thing) and would take ages for me to write it all up on here, I will leave you to finish it yourself 🙂
Because he is asking for the NPV, the first thing I would do is discount and calculate the present value of all the flows mentioned.
So, 100,000 in one year discounts at 10% to 90,900
100,000 in two years discounts at 10% to 82,600
200,000 in two years discount at 10% to 165,200
200,000 in one year discounts at 10% to 181,800
and so on.Then I would list all the different things that can happen, and for each of them calculate the NPV and the probability.
So…..
One possibility is 100,000 in 1 year followed by nil in 2 years.
The NPV will be 90,900 + 0 – 300,000 = (209,100)
The probability of this happening is 0.25 x 0.25 = 0.0625
(100,000 in year 1 will happen 25 times out of a 100, and nil in year to will happen 25% of those 25 time = 6.25 times out of a 100).Second possibility is 100,000 in year 1 followed by 100,000 in year 2.
The NPV for this will be 90,900 + 82,600 – 300,000 = (126,500)
The probability of this happening is 0.25 x 0.5 = 0.125Third possibility is 100,000 in year 1 followed by 200,000 in year 2
The NPV for this will be 90,900 + 165,200 – 300,000 = (43,900)
The probability of this happening is 0.25 x 0.25 = 0.0625Fourth possibility is 200,000 in year 1 followed by 100,000 in year 2
The NPV of this will be 181,800 + 82,600 – 300,000 = (35,600)
The probability of this happening is 0.50 x 0.25 = 0.125And so on………
Then I would list all the possible NPV’s and their probabilities:
1) (209,100) 0.0625
2) (126,500) 0.125
3) (43,900) 0.0625
4) (35,600) 0.125
etc..To get the overall expected NPV, you then simply multiply each of the possible NPV’s by its probability, and add them up.
To get the probability of the NPV being negative, simply add up all the probabilities of those giving a negative NPV.
I hope that helps 🙂
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