A firm has an investment proposal, requiring an outlay of 12 crore. The investment proposal is expected to have two years economic life with no…

(i) The decision tree diagram is presented in the chart, identifying various paths and outcomes, and the computation of various paths/outcomes and NPV of each path are presented in the following tables: Decision Tree Diagram Path No. Joint Probability Year 1 x Year 2 1 0.07 2 0.35 3 0.28 4 0.15 5 0.09 6 0.06 1.00 (ii) The Net Present Value (NPV) of each path at 15% discount rate is given below: (₹ in crore) Path Year 1 Cash Flows (₹) Year 2 Cash Flows (₹) Total Cash Inflows (PV) (₹) Cash Outflows (₹) NPV (₹) 1. 7.50 x 0.870 = 6.53 3.60 × 0.756 = 2.72 9.25 (12) (-) 2.75 2. 6.53 4.80 x 0.756 = 3.63 10.16 (12) (-) 1.84 3. 6.53 6.60 × 0.756 = 4.99 11.52 (12) (-)0.48 4. 9.00 x 0.870 = 7.83 6.00 × 0.756 = 4.54 12.37 (12) 0.37 5. 7.83 7.50 × 0.756 = 5.67 13.50 (12) 1.50 6. 7.83 9.00 x 0.756 = 6.80 14.63 (12) 2.63 Statement showing Expected Net Present Value (₹ in crore) Path NPV (₹) Joint Probability Expected NPV (₹) 1 (-) 2.75 0.07 (-) 0.19 2 (-) 1.84 0.35 (-) 0.64 3 (-) 0.48 0.28 (-) 0.13 4 0.37 0.15 0.06 5 1.50 0.09 0.14 6 2.63 0.06 0.16 (-) 0.60 (iii) The best outcome will be path 6 when the NPV is at 2.63 crore. The probability of occurrence of this NPV is 6% and hence expected NPV of 0.16 crore (iv) If the worst outcome is realized the project will yield NPV of Negative - 2.75 crore. The probability of occurrence of this NPV is 7% and hence Negative NPV of 0.19 crore (path 1). (v) The project should not be accepted because the expected NPV is negative - 0.60 crore based on joint probability.