A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.20 probability that demand will be low and a 0.80 probability that demand will be high. If the firms builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium size facility as a hedge: if demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million. Analyze and prepare a decision tree. What is the best alternative in terms of expected monetary value?

A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.20 probability that demand will be low and a 0.80 probability that demand will be high. If the firms builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium size facility as a hedge: if demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million. Analyze and prepare a decision tree. What is the best alternative in terms of expected monetary value?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 12P

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