Your company is planning to introduce a new online shopping service. To reduce risk, senior management propose developing the service in three stages:

a) A market test for one year with a few customers at a cost of $1 million. The likelihood of success for this test is estimated to be 75%.

b) A introductory period of one year, if the market test is successful. During this test the most widely ordered products will be available through the service to a wider audience. This phase of the project is estimated to cost $2.5 million with have a 50% chance of success.

c) Full roll-out of the service at the end of the second year if the introductory period is successful. This phase is estimated to cost $15 million and is expected to start generating revenue only by the end of the third year.

There are 3 possible outcomes from the full roll out:

Outcome

Probability

Year 4 Revenue

Year 5 Revenue

Year 6 Revenue

Year 7 Revenue

Huge Success

25%

$12M

$15M

$18M

$21M

Moderate Success

50%

$7M

$9M

$11M

$13M

Failure

25%

-$3M

-$4M

-$5M

-$6M

Constructa decision tree and list all the outcomes and cumulative probabilities (it maybe easier to construct the tree in a different program and copy and paste intoExcel)

ii) Assume all the values are present values. Should the company pursue this project based on the expected NPV?