A firm introduces a new product and must enter the market now to secure a niche...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
A firm introduces a new product and must enter the market now to secure a niche but it will not know the demand for the product until after a year. There is a 75% chance that demand will be high and a 25% chance that it will be low. If demand is high, same firm will earn $4M in the first year, after which a decision must be made to keep the project as is and not expand. If it does not expand, PV of cash flow at the end of year one will be $16M. If it takes advantage of high demand to expand, the cost will be $2M and cash flow at year end will be $30M. If demand is low, said project will earn $0.8M in the first year and a decision must be made to keep project as is and not terminate. If the project is not terminated, PV of cash flow will be $3M in year one. If the company decides to terminate, cost of termination will be $0.5M and PV of cash flow from liquidation of project will be $6M at the end of year one. A. B. i. Draw a decision tree for this project. ii. Determine the value of the real options. (7 marks) (8 marks) i. Briefly explain what is meant by a real option in capital budgeting. Give TWO (2) examples. (3 marks) ii. Why is it important to consider real options in the capital budgeting process? A firm introduces a new product and must enter the market now to secure a niche but it will not know the demand for the product until after a year. There is a 75% chance that demand will be high and a 25% chance that it will be low. If demand is high, same firm will earn $4M in the first year, after which a decision must be made to keep the project as is and not expand. If it does not expand, PV of cash flow at the end of year one will be $16M. If it takes advantage of high demand to expand, the cost will be $2M and cash flow at year end will be $30M. If demand is low, said project will earn $0.8M in the first year and a decision must be made to keep project as is and not terminate. If the project is not terminated, PV of cash flow will be $3M in year one. If the company decides to terminate, cost of termination will be $0.5M and PV of cash flow from liquidation of project will be $6M at the end of year one. A. B. i. Draw a decision tree for this project. ii. Determine the value of the real options. (7 marks) (8 marks) i. Briefly explain what is meant by a real option in capital budgeting. Give TWO (2) examples. (3 marks) ii. Why is it important to consider real options in the capital budgeting process?
Expert Answer:
Answer rating: 100% (QA)
Solution A i New Product Decision Tree High Demand Not Expand 75 Low Demand 25 Year Cash Flow 1 2 Year 1 2 4 16 EXPAND Cash flow 4 30 Cost of Real opt... View the full answer
Related Book For
Managerial Accounting
ISBN: 978-0618777181
8th Edition
Authors: Susan V. Crosson, Belverd E. Needles
Posted Date:
Students also viewed these general management questions
-
Given the following cash flow at the end of each year, what is the future value of this cash flow at 3%, 9%, and 18% interest rates at the end of year 7? year 1. $15,000 year 2. $20,000 year 3....
-
JTZ Furniture is considering a new product and must make a go or no-go decision before tomorrows planning team meeting. Market research shows that the unit selling price agreeable to potential...
-
MTZ Furniture is considering a new product and must make a go or no-go decision before tomorrow's planning team meeting. Market research shows that the unit selling price agreeable to potential...
-
Consider the decision tree for a company deciding whether to continue product development as shown below. If the company achieves technical success on its own, what is the expected monetary value of...
-
Match each of the numbered definitions with the correct term in the following list. Write the letter of your choice in the answer column. a. Bill of sale b. Certificate of title c. Condition...
-
A convergent-divergent nozzle with an exit-to-throat area ratio of 1.616 has exit and reservoir pressures equal to 0.947 and 1.0atm, respectively. Assuming isentropic flow through the nozzle,...
-
Is the collision in Example 10.7 elastic? Data from Example 10.7 Pucks 1 and 2 slide on ice and collide. The inertia of puck 2 is twice that of puck 1 . Puck 1 initially moves at \(1.8 \mathrm{~m} /...
-
On January 1, 2012, Kristen Corporation had the following stockholders equity accounts. Common Stock ($20 par value, 60,000 shares issued and outstanding)....................... $1,200,000 Paid-in...
-
(08 Marks) In the Fig.1(c), compare the output of the network, if the activation function is a sigmoid 1 function y=- and (X1, X2) (1, 1). 1+e 1+1 AYY Y YC.) B YC. ye D 46 (06 Marks)
-
The following information relates to Kamelwa limited a retail grocer engaged in buying and selling of foodstuffs. (1) Budgeted sales (2021) : January K500,000 February K450,000 March K625,000 April...
-
Of the three parameters mass, angle, length which has the strongest influence in a simple pendulum?
-
A consumer has the following preferences u(11, 12) = log (11) + 1 Suppose the price of good 1 is p and the price of good 2 is P2. The consumer has income m. (a) Find the optimal choices for the...
-
What else can the Eniscope connect to outside of the standard CTs? MODBUS Devices HTML Bluetooth WiFi Temperature Probes Air Devices Pulse Meters
-
A Birr 100, 000 software project is scheduled for 4 weeks. At the end of the third week, the project is 50% complete and the actual costs to date are Birr 90,000. Examine the project health using...
-
Describe the operation of Vlan Trunking Protocol ( VTP ) in transparent mode with the help of an illustrative diagram?
-
What alternate budget-classification systems for the School of Public Affairs at Enormous State University are possible? Identify
-
Discuss the Carnot cycle and its importance in the analysis of thermodynamic systems. Explain the efficiency of the Carnot cycle and its limitations . Provide an example where the principles of the...
-
For the next several days, take notes on your listening performance during at least a half-dozen situations in class, during social activities, and at work, if applicable. Referring to the traits of...
-
Heidi Layne recently inherited a trust fund from a distant relative. On January 2, the bank managing the trust fund notified Layne that she has the option of receiving a lump-sum check for $175,500...
-
Diamond Tuxedo Rental has been in business for four years. Because the company has recently had a cash flow problem, management wonders whether there is a problem with receivables or inventories....
-
Turners Pots, Inc., manufactures sets of heavy-duty cookware. It has just completed production for August. At the beginning of August, its Work in Process Inventory account showed direct materials...
-
What is the difference between leading zeros and trailing zeros? Which ones are considered significant digits?
-
What is the simplest way to convert a quantity given in one unit to the same quantity given in a different unit?
-
Explain the difference between number of digits, number of decimal places, and number of significant digits in a numerical value. Illustrate your explanation using the number 0.03720 .
Study smarter with the SolutionInn App