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

Sundaram Auto Ltd will spend ₹10,00,000 on a new line. If demand is high (probability 0.6), the present value of inflows will be ₹18,00,000. If demand is low (probability 0.4), the present value of inflows will be ₹6,00,000. What is the expected NPV of the project?

The expected NPV is ₹3,20,000. The probability-weighted present value of inflows is 0.6 × 18 lakh plus 0.4 × 6 lakh, which equals ₹13.2 lakh. Subtracting the ₹10 lakh outlay gives the expected NPV.

  1. A₹2,00,000
  2. B₹3,20,000Correct
  3. C₹80,000
  4. D₹13,20,000

Explanation

Expected PV of inflows = 0.6 × 18,00,000 + 0.4 × 6,00,000 = 10,80,000 + 2,40,000 = 13,20,000. Expected NPV = 13,20,000 − 10,00,000 = 3,20,000. Reversing the probabilities gives 80,000, and a simple average gives 2,00,000. Stating 13,20,000 forgets to deduct the outlay.

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