Problem 5-8 (Algo)
Expando, Incorporated, is considering the possibility of building an additional factory that would produce a new addition to its product line. The company is currently considering two options. The first is a small facility that it could build at a cost of $9 million. If demand for new products is low, the company expects to receive $9 million in discounted revenues (present value of future revenues) with the small facility. On the other hand, if demand is high, it expects $12 million in discounted revenues using the small facility.
The second option is to build a large factory at a cost of $10 million. Were demand to be low, the company would expect $12 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $15 million. In either case, the probability of demand being high is 0.40, and the probability of it being low is 0.60. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new products.
Calculate the NPV for the following:
Small facility: Cost = $9 million; Revenues if low demand = $9 million; Revenues if high demand = $12 million.
Large facility: Cost = $10 million; Revenues if low demand = $12 million; Revenues if high demand = $15 million.
No construction: No additional revenue.
Probabilities: High demand = 0.40; Low demand = 0.60.
Note: Leave no cells blank – be certain to enter
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