Jeff Himm has recently been hired as a financial analyst for the Bunich Corporation. Bunich has traditionally used the payback method in conjunction with NPV as a way to assess the risk of capital investments that the firm makes. Jeff is a new MBA graduate and is eager to put to work the tools he has learned.
One project that the firm is considering has an expected NPV of $1.5 million. An analysis of the cash flows of the project suggests that the most optimistic estimate of the NPV is $4 million, and the most pessimistic estimate is a negative $1 million. By most optimistic, Jeff explains that it is a value not expected to be exceeded more than 10 percent of the time. By most pessimistic, Jeff explains that it is a value not expected to be less than more than 10 percent of the time. Cash flows are expected to be normally distributed.
a. What is the probability that this project will be acceptable?
b. What is the probability that this project will have an NPV in excess of $1 million?