3. Use Expected NPV and PVR analysis for a minimum rate of return of 20.0% to evaluate the economic potential of buying and developing the rights to a new process with the following estimated costs, revenues, and success probabilities. The process rights would cost $100,000 at time zero, and it is considered 100% certain that an experimental development pilot plan work will be done one year later for a cost of $500,000. There is a 60.0% probability that the experimental development results will look good enough to take the project to production for a $400,000 capital cost at year one. If the experimental development results are unsatisfactory, a pilot plan abandonment cost of $40,000 will be incurred at year 1. If the project is taken to production, it is estimated there will be a 50.0% probability of generating production that will give $450,000 peryear net positive cash flow for years 2 through 10, a 35.0% probability of generating $300,000 peryear net positive cash flow for years 2 through 10, with a 15.0% probability of the project development being unsuccessfuldue to unforeseen technical difficulties giving a year 2 salvage value of $250,00o for production equipment. (Hint: use expected NPV and expected MCE for PVR calculation.)
3. Use Expected NPV and PVR analysis for a minimum rate of return of 20.0% to evaluate the economic potential of buying and developing the rights to a new process with the following estimated costs, revenues, and success probabilities. The process rights would cost $100,000 at time zero, and it is considered 100% certain that an experimental development pilot plan work will be done one year later for a cost of $500,000. There is a 60.0% probability that the experimental development results will look good enough to take the project to production for a $400,000 capital cost at year one. If the experimental development results are unsatisfactory, a pilot plan abandonment cost of $40,000 will be incurred at year 1. If the project is taken to production, it is estimated there will be a 50.0% probability of generating production that will give $450,000 peryear net positive cash flow for years 2 through 10, a 35.0% probability of generating $300,000 peryear net positive cash flow for years 2 through 10, with a 15.0% probability of the project development being unsuccessfuldue to unforeseen technical difficulties giving a year 2 salvage value of $250,00o for production equipment. (Hint: use expected NPV and expected MCE for PVR calculation.)
Chapter11: Capital Budgeting And Risk
Section: Chapter Questions
Problem 16P
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Transcribed Image Text:3. Use Expected NPVand PVR analysis for a minimum rate of return of 20.0% to evaluate the
economic potential of buying and developing the rights to a new process with the following
estimated costs, revenues, and success probabilities. The process rights would cost $100,000
at time zero, and it is considered 100% certain that an experimental development pilot plan
work will be done one year later for a cost of $500,000. There is a 60.0% probability that the
experimental development results will look good enough to take the project to production for
a $400,000 capital cost at year one. If the experimental development results are unsatisfactory,
a pilot plan abandonment cost of $40,000 will be incurred at year 1. If the project is taken to
production, it is estimated there will be a 50.0% probability of generating production that will
give $450,000 per year net positive cash flow for years 2 through 10, a 35.0% probability of
generating $300,000 per year net positive cash flow for years 2 through 10, with a 15.0%
probability of the project development being unsuccessful due to unforeseen technical
difficulties giving a year 2 salvage value of $250,0oo for production equipment. (Hint: use
expected NPV and expected MCE for PVR calculation.)
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