Boris’ Bucket Works, Inc. (BBW) is the maker of new “easy spill” buckets. These buckets have quickly gained market share and now control 90 percent of the spillable bucket market. BBW is looking to do a product line expansion into the “spill-free” bucket market. The weighted cost of capital for BBW has been estimated to be 16 percent. BBW’s beta is 1.3 and the risk-free rate is 6 percent. BBW has a capital structure composed of 40 percent debt and 60 percent equity. The marginal tax rate is 40 percent.
Using pro forma statements prepared by Boris, the expected NPV of this project is –$5 million. The most optimistic estimate of the NPV is $10 million and the most pessimistic estimate is –$20 million. By most optimistic, Boris means a value not likely to be exceeded more than 5 percent of the time. By most pessimistic, he means a value not likely to fall below more than 5 percent of the time. The distribution of NPV is assumed to be normally distributed.
a. What is the probability that this project will be acceptable to BBW, if the goal is to maximize shareholder wealth?
b. What other factors might be important in your analysis? Be specific.