You have been asked to evaluate the following investment opportunity. A small firm is available for purchase at an initial cost of $150,000, to be paid to the current owner in equal installments over the next five years. The firm has been generating annual revenues of $100,000. Operating costs are 65% of revenue, in each period. Tip: Under these assumptions, you should get a base case NPV (at a discount rate of 10% and base tax rate of 36%) for this project of $12.131 In light of the fact that most of your information about this firm comes from the current owner, you are concerned that some of your assumptions may be inaccurate. After some research, you have determined the following about the key inputs to this problem Actual revenues could be as low as $60,000 or as high as $125,000. The most likely amount is $100,000. Revenues in successive years are independent. Operating costs could be as low as 55 percent of revenues or as high as 75 percent, with any value in between being equally likely. Costs in successive years are independent. The tax rate in any year will be 36 percent with probability 0.4 and 40 percent with probability 0.6, depending on factors outside your control and independent from year to year. In the case of negative taxable income, you will have other income, so the tax effects represented in the model will still hold. For tax purposes, the firm's earnings would appear on your personal income tax return, and the applicable tax rate would be about 36 percent. Your investment would be deductible when calculating taxes.
a. What is the expected value NPV for the firm under the assumptions given above? QUESTION 9 5 points Save b. What is the probability that the NPV will be negative? (Provide answer in decimal form)
c. What is the probability that the cash flow will be positive in all five years? (Provide answer in decimal form)