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project's expected NPV

(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.
    First, HYC would have to invest $10,000 at t=0 for the design and model tank testing of the new boat. HYCâ??s managers believe that there is a 60% probability that this phase will be successful and the project will continue. If Stage 1 is not successful, the project will be abandoned with zero salvage value.
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?

Solution Summary

Construct a decision tree and determine the project's expected NPV.