5. Flexibility options Stay Swift Corp. is looking at investing in a production facility that will require an initial investment of $500,000. The facility will have a three-year useful life, and it will not have any salvage value at the end of the project’s life. If demand is strong, the facility will be able to generate annual cash flows of $255,000, but if demand turns out to be weak, the facility will generate annual cash flows of only $135,000. Stay Swift Corp. thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak. If the company uses a project cost of capital of 13%, what will be the expected net present value (NPV) of this project? -$37,596 -$39,575 -$29,681 -$19,788 Stay Swift Corp. could spend $510,000 to build the facility. Spending the additional $10,000 on the facility will allow the company to switch the products they produce in the facility after the first year of operations if demand turns out to be weak in year 1. If the company switches product lines because of low demand, it will be able to generate cash flows of $250,000 in years 2 and 3 of the project. What is the expected NPV of this project if Stay Swift Corp. decides to invest the additional $10,000 to give themselves a flexibility option? (Note: Do not round your intermediate calculations.) $31,775 $29,952 $67,393 $35,306 What will be the value of Stay Swift Corp.’s flexibility option?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 16P: Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of...

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5. Flexibility options

Stay Swift Corp. is looking at investing in a production facility that will require an initial investment of $500,000. The facility will have a three-year useful life, and it will not have any salvage value at the end of the project’s life. If demand is strong, the facility will be able to generate annual cash flows of $255,000, but if demand turns out to be weak, the facility will generate annual cash flows of only $135,000. Stay Swift Corp. thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak.

If the company uses a project cost of capital of 13%, what will be the expected net present value (NPV) of this project?

-$37,596

-$39,575

-$29,681

-$19,788

Stay Swift Corp. could spend $510,000 to build the facility. Spending the additional $10,000 on the facility will allow the company to switch the products they produce in the facility after the first year of operations if demand turns out to be weak in year 1. If the company switches product lines because of low demand, it will be able to generate cash flows of $250,000 in years 2 and 3 of the project.

What is the expected NPV of this project if Stay Swift Corp. decides to invest the additional $10,000 to give themselves a flexibility option? (Note: Do not round your intermediate calculations.)

$31,775

$29,952

$67,393

$35,306

What will be the value of Stay Swift Corp.’s flexibility option?

Expert Solution

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Net present value is the method capital budgeting that is used to determine present worth of the projects. Investor use net present value technique to evaluate their investment alternatives and take decisions of acceptance or rejection of projects.

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