QUESTION 3 (20 MARKS)

Mawar Bhd is evaluating a new saw with a life of 2 years. The saw costs RM5,000 and future after-tax cash flows depend on demand for the companys products. In year 1 there is a 40 percent probability that there will be a net inflow of RM2,500 and 60 percent probability it will be RM4,500. If the first year inflow is RM2,500 then year twos cash flow can be RM1,500 or RM3,000 with a probability of 0.6 and 0.4 respectively. If the first years cash flow is RM4,500 then year twos cash flow can be RM3,000 or RM6,000 with a probability of 0.3 and 0.7 respectively. The discount rate is 10 percent.

1. Draw a tree diagram to describe the above probabilities.

(4 marks)

2. Calculate the Net Present Value (NPV) for each branch of the tree diagram.

(8 marks)

3. Calculate the joint probability (PNPV) and expected Net Present Value, E(NPV) for the above decision of the firm.

(8 marks)