Yoran Yacht Company (YYC), a prominent sailboat builder in Victoria, B.C., is considering designing a new 30-foot
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First, YYC would have to invest $10,000 at t = 0 for the design and model tank testing of the new boat. YYC's managers believe that there is a 60% probability that this phase will succeed and that 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 moulds and producing two prototype boats. This would cost $500,000 at t = 1. If the boats test well, YYC would go into production. If they do not, the moulds and prototypes could be sold for $100,000. The man- agers 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 economy 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. YYC's corporate cost of capital is 12%.
a. Assume that this project has average risk. Construct a decision tree and determine the project's expected NPV.
b. Find the project's standard deviation of NPV and coefficient of variation (CV) of NPV. If YYC'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? Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...
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Related Book For
Financial Management Theory and Practice
ISBN: 978-0176517304
2nd Canadian edition
Authors: Eugene Brigham, Michael Ehrhardt, Jerome Gessaroli, Richard Nason
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