Northwest Entertainment Inc. operates a multiplex cinema that has nine small theaters in one building. Business has been good lately and management is considering a project that will add five screens at an estimated cost of $3 million. The success of the expansion depends on whether local demand over the next two years will support the additional capacity. Demand is believed to depend on the local economy. An economist at a nearby university has predicted a 90% probability of continued prosperity in the area and a 10% chance of a moderate downturn. Management feels that if prosperity continues the new theaters will generate a profit margin of $2 million in the first year and $3 million in the second. A moderate downturn would produce contributions of $1.5 and $2 million. Northwest’s cost of capital is 12%.
a. Draw a decision tree for the project.
b. Calculate the NPV along each path.
c. Develop the probability distribution of the project’s NPV.
d. Calculate the project’s expected NPV.
e. Make a recommendation on the project with an appropriate comment on risk.

  • CreatedMay 14, 2015
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