A nationwide real estate corporation is considering adding a new service line to sell the house of a client that buys another house through one of their agencies. It has determined that the first cost would be $80 million cash available for full implementation. However, John, the corporate vice president of sales, is not sure how well the service will be received, so he has projected added revenues using optimistic, most likely, and pessimistic estimates of $35 million, $25 million, and $10 million, respectively, with equal probability for each. Instead of expanding now, the company could implement a pilot program for 1 year in a limited geographic area that will cost $4 million now. (The full-scale service will still cost $80 million if implemented later.) This will provide the company with the option to move forward or cancel the project. The criterion identified to move ahead with full-scale implementation is that added revenues during the pilot program must exceed $900,000. In this case, the pessimistic estimate will be eliminated, and equal probability placed on the remaining revenue projections. If the company uses a 5-year planning horizon and a MARR of 12% per year, should the company go ahead with the fullscale service now or take the option to implement the pilot program for 1 year?
A nationwide real estate corporation is considering
adding a new service line to sell the house of
a client that buys another house through one of
their agencies. It has determined that the first
cost would be $80 million cash available for full
implementation. However, John, the corporate
vice president of sales, is not sure how well the
service will be received, so he has projected
added revenues using optimistic, most likely, and
pessimistic estimates of $35 million, $25 million,
and $10 million, respectively, with equal
probability for each.
Instead of expanding now, the company could
implement a pilot program for 1 year in a limited
geographic area that will cost $4 million now. (The
full-scale service will still cost $80 million if implemented
later.) This will provide the company
with the option to move forward or cancel the project.
The criterion identified to move ahead with
full-scale implementation is that added revenues
during the pilot program must exceed $900,000. In
this case, the pessimistic estimate will be eliminated,
and equal probability placed on the remaining
revenue projections. If the company uses a
5-year planning horizon and a MARR of 12% per
year, should the company go ahead with the fullscale
service now or take the option to implement
the pilot program for 1 year?
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