A decision tree shows a 30 percent probability of $2 million in returns and a 70 percent chance of $1 million in returns.What is the maximum you would invest today in this project if the cash in-flow occurs one year in the future and the discount rate is 10 percent? (Use the values in dollar)
A)$818,182
B)$1,181,818
C)$1,300,000
D)$1,363,636

Question

Quizplus · Accepted Answer

To calculate the present value of the expected returns, we can use the formula: PV = (Probability 1 x Cash flow 1)/(1+r) + (Probability 2 x Cash flow 2)/(1+r), where PV is the present value, Probability is the probability of each cash flow occurring, Cash flow is the cash inflow, and r is the discount rate.

Using this formula, we get:
PV = (0.3 x 2,000,000)/(1+0.1) + (0.7 x 1,000,000)/(1+0.1)
PV = $1,181,818.18

Therefore, investing anything more than $1,181,818.18 would give a negative net present value and would not be the best choice.

A Decision Tree Shows a 30 Percent Probability of $2