Easier way to calculate NPV with failure rates rates

edgeon

I use this method, which thus far has yielded consistently correct answers. Can someone tell me if this is theoretically sound? (Obviously this won't work with multiple payoffs, but since all the numericals involve only initial CF and a final CF, I've been doing ok...)

I calculate prob of success by multiplying all the (1-p), where p=prob. of failure.

I then multiply this overall probability of success with the CF at the end. I get a modified CF.

I then calculate NPV using modified CF and initial CF, and get the right answer straightaway.

(The textbook method and the ones used in the explanations are really long and tedious, involving two stages of multiplication and subtraction, so I'm gonna use mine unless one of you brilliant folks can point out a hole in my theory)

manasib

you go 42k/(1+r)^n

then you subtract the initial investment

JPSem

I got P(success)=0.2866 (0.70x.85x.80x.75... something like that)

Remember, p(Success) is the product of SUCCESS probabilities, the question gives us failure probabilities.

I multiply P(success) by CF final (10 million), I get 2,866,000. Then I enter this as my CF5, enter -1million as Cf0, and calculate NPV at the given rate (18% I think)

I use the CF function, not the PV, FV function.

lc26mizzou

Sid, so you take P(Success) x Projects Final Payout? Then how do you calculate the NPV for that?

So with problem #110 on the CFAI afternoon mock, your P(Success) = .0042; multiplied by $10mm you get $42,000. Is that right, and if so, what next?

Thanks!!!

shootingstar

This is sound method, I used it before I forgot. If I'm not mistaken, there is calculation using this methon in Schweser notes. So you can keep using it confidently.