Answered: However, it would increase the…

However, it would increase the probability of success to 75%. The relevant discount rate is 11%. Should Gadgeteer test market the widget?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 5P

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All American Telephones Inc. is considering the production of a new cellphone. The project will require an investment of $13 million. If the phone is well received, the project will produce cash flows of $8 million a year for 3 years, but if the market does not like the product, the cash flows will only be $2 million per year. There is a 50% probability of both good and bad market conditions. All AMerican can delay the project a year while it conducts a test to determine whether demand will be strong or weak. The delay will not affect the dollar amounts involved project's investment or its cash flows- only their timing. Because of the anticipated shifts in technology, the 1-year delay means that cash flows will continue only 2 years after the initial investment is made. All-American's WACC is 8%. What action do you recommend?
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