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CMA Final · Strategic Financial Management · Evaluation of Risky Proposals for Investment Decisions

A project of Tarini Industries has an expected NPV of Rs 40 lakh under a good economy (probability 0.3), Rs 10 lakh under a normal economy (probability 0.5) and a loss of Rs 20 lakh under a poor economy (probability 0.2). What is the expected NPV?

The expected NPV is Rs 13 lakh. It is the probability-weighted average of the outcomes: 0.3 times 40 plus 0.5 times 10 plus 0.2 times negative 20, which gives 12 plus 5 minus 4. The loss under the poor economy must be included with its negative sign.

  1. ARs 10 lakh
  2. BRs 13 lakhCorrect
  3. CRs 16 lakh
  4. DRs 30 lakh

Explanation

Expected NPV = 0.3x40 + 0.5x10 + 0.2x(-20) = 12 + 5 - 4 = Rs 13 lakh. Rs 16 lakh results from ignoring the loss in the poor economy (12+5-1 is not valid; it comes from treating the loss as zero then rounding wrongly), and Rs 10 lakh is the simple average of 40, 10 and -20.

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