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a. Using the above information, compute the Net Present Value (NPV) if the company delayed the project for 1 year. b. Holding everything else constant, what is the expected NPV of the decision if the probabilities for the three scenarios (after 1 year) are as follows: high (20%), medium (48%), and low (32%)? c. From your answers in (a) and (b) above, what conclusion can be derived, and why?

a. Using the above information, compute the Net Present Value (NPV) if the company delayed the project for 1 year. b. Holding everything else constant, what is the expected NPV of the decision if the probabilities for the three scenarios (after 1 year) are as follows: high (20%), medium (48%), and low (32%)? c. From your answers in (a) and (b) above, what conclusion can be derived, and why?

Intermediate Financial Management (MindTap Course List)
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter14: Real Options
Section: Chapter Questions
Problem 3MC: Tropical Sweets is considering a project that will cost $70 million and will generate expected cash...
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Flexcell Bhd is considering investing in the production of a new technology, a handheld communication device, the target market is young undergraduates. The estimated investment cost for this project is RM100 million with 3 year project life. Demand for the product, and therefore the project risk, is a function of the demand for Internet connections. The CFO working with marketing, currently estimates a 25% chance that such demand will be high, a 50% probability that demand will be medium, and a 25% probability that demand will be low. Associated after tax cash flows under each of these three market scenarios are estimated as follows: RM70 million, RMS0 million, and RM5 million. For projects of this nature, a 15% discount rate (equal to the firm's weighted average cost of capital) is assumed. Because starting the project immediately on day 1 results in negative NPV of RM0.109 million, management of the company has decided to avoid risk by delaying the implementation of the project for 1 year, i.e. to wait and see. It will still spend RM100 million investment cost, and expects to maintain customer demands of RM70 million and RM50 million if customer demands are high or medium respectively. However, if customer demand turns out to be low after 1 year, then no investment will be made. At 15% discount rate, the present value (PV) factors are: Year 1 (0.870), Year 2 (0.756), Year 3 (0.658), Year 4 (0.572). Required: a. Using the above information, compute the Net Present Value (NPV) if the company delayed the project for 1 year. b. Holding everything else constant, what is the expected NPV of the decision if the probabilities for the three scenarios (after 1 year) are as follows: high (20%), medium (48%), and low (32%)? c. From your answers in (a) and (b) above, what conclusion can be derived, and why?
Transcribed Image Text:Flexcell Bhd is considering investing in the production of a new technology, a handheld communication device, the target market is young undergraduates. The estimated investment cost for this project is RM100 million with 3 year project life. Demand for the product, and therefore the project risk, is a function of the demand for Internet connections. The CFO working with marketing, currently estimates a 25% chance that such demand will be high, a 50% probability that demand will be medium, and a 25% probability that demand will be low. Associated after tax cash flows under each of these three market scenarios are estimated as follows: RM70 million, RMS0 million, and RM5 million. For projects of this nature, a 15% discount rate (equal to the firm's weighted average cost of capital) is assumed. Because starting the project immediately on day 1 results in negative NPV of RM0.109 million, management of the company has decided to avoid risk by delaying the implementation of the project for 1 year, i.e. to wait and see. It will still spend RM100 million investment cost, and expects to maintain customer demands of RM70 million and RM50 million if customer demands are high or medium respectively. However, if customer demand turns out to be low after 1 year, then no investment will be made. At 15% discount rate, the present value (PV) factors are: Year 1 (0.870), Year 2 (0.756), Year 3 (0.658), Year 4 (0.572). Required: a. Using the above information, compute the Net Present Value (NPV) if the company delayed the project for 1 year. b. Holding everything else constant, what is the expected NPV of the decision if the probabilities for the three scenarios (after 1 year) are as follows: high (20%), medium (48%), and low (32%)? c. From your answers in (a) and (b) above, what conclusion can be derived, and why?
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