Probability of cashflows with NPV

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May 25, 2014 at 3:42 pm #170725
Ali
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Hi,

If an NPV question gives you a probability of cash flows how do you work out what cash flow to put in what year.

For example the probability in year 1 of 150,000 is 40% and 220,000 is 50%
then in year two if year 1 cash flows increase by 150,000 …..
or in year two if year 1 cash flows increase by 220,000….

Thanks
May 25, 2014 at 5:32 pm #170773
John Moffat
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You use the expected values.
If it was like you are suggesting then you would effectively draw a decision tree (which you studied for F5). However he has only ever done something like this once, and it was actually very simple (and was not calculating NPV’s).

(However, your year 1 example is not possible for the exam – what about the remaining 10%? 🙂 )
May 26, 2014 at 8:08 pm #171058
Ali
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Oops yes I meant for year 1 60% instead of 50%.

So, I would have two NPV’s one for the expected values if Year 1 cash flows increase by 150,000 and another expected value and NPV if Year 1 cash flows increase by 220,000?

Thanks
May 26, 2014 at 8:50 pm #171067
John Moffat
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No.

You use the expected cash flows – so you have one figure replacing the uncertain ones – and then you calculate the NPV.
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