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What is the project's expected NPV?

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Consider the following project data:

(1) A $500 feasibility study will be conducted at t = 0.

(2) If the study indicates potential, the firm will spend $1,000 at t = 1 to build a prototype. The best estimate now is that there is an 80 percent chance that the study will indicate potential, and a 20 percent chance that it will not.

(3) If reaction to the prototype is good, the firm will spend $10,000 to build a production plant at t = 2. The best estimate now is that there is a 60 percent chance that the reaction to the prototype will be good, and a 40 percent chance that it will be poor.

(4) If the plant is built, there is a 50 percent chance of a t = 3 cash inflow of $16,000 and a 50 percent chance of a $13,000 cash inflow.


If the appropriate cost of capital is 10 percent, what is the project's expected NPV?

a. -$35

b. -$12

c. $ 0

d. $12

e. $35

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Solution Summary

Calculations for determining net present value are formatted in a table in the attached Excel file. The correct answer is $35.

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(Sequential Decisions)  The Haugen Yacht Company (HYC), a prominent sailboat builder in Florida, may design a new 30-foot sailboat based on the â??wingedâ? keels first introduced on the 12-meter yachts that raced for the Americaâ??s Cup.
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The next stage, if undertaken, would consist of making the molds and producing two prototype boats. This would cost $500,000 at t=1. If the boats test well, HYC would go into production. If they do not, the molds and prototypes could be sold for $100,000. The managers estimate that the probability is 80% that the boats will pass testing, and that Stage 3 will be undertaken.
Stage 3 consists of converting an unused production line to produce the new design. This would cost$1,000,000 at t=2. If the company is strong at this point, the net value of sales would be $3,000,000, while if the economy is weak, the net value would be $1,500,000. Both net values occur at t=3, and each state of the economy has a probability of 0.5. HYCâ??s corporate cost of capital is 12%.

a. Assume that this project has average risk. Construct a decision tree and determine the projectâ??s expected NPV.
b. Find the projectâ??s standard deviation of NPV and coefficient of variation (CV) of NPV. If HYCâ??s average project had a CV of between 1.0 and 2.0, would this project be of high, low, or average stand-alone risk?

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