PJP, an industrial manufacturer, is considering a new capital investment project to make and produce and sell a new type of electrical generator. The first stage of the project requires an investment of $8,000 now for the initial design and market research. There is a 40% probability that this phase will be successful. If it is not successful (probability 60%), the project will be abandoned with zero salvage value. If the first stage is successful, a further investment of $300,000 will be required one year from now to make and test prototype generators. If this second stage is not successful (probability 55%), the prototypes could be sold for $40,000. If it is successful (probability 45%), PJP would go ahead and produce the generator. Further machinery for full production would cost $600,000 two years from now. The net cash flows from production and sales of the generator will be either $250,000 or $200,000 every year into perpetuity, depending on whether the demand is strong (probability 50%) or weak (probability 50%). Assume these cash flows occur at the year ends with the first of them occurring three years from now. PJP's cost of capital is 10%. Assume investors are risk neutral. a) Construct a decision tree and determine the expected Net Present Value of the project. Should the project be undertaken? b) Assume that PJP can pay another firm to carry out the first two stages and report their findings to PJP two years from now. What is the maximum amount PJP should pay for this?
PJP, an industrial manufacturer, is considering a new capital investment project to make and produce and sell a new type of electrical generator.
The first stage of the project requires an investment of $8,000 now for the initial design and
If the first stage is successful, a further investment of $300,000 will be required one year from now to make and test prototype generators. If this second stage is not successful (probability 55%), the prototypes could be sold for $40,000. If it is successful (probability 45%), PJP would go ahead and produce the generator. Further machinery for full production would cost $600,000 two years from now.
The net cash flows from production and sales of the generator will be either $250,000 or $200,000 every year into perpetuity, depending on whether the demand is strong (probability 50%) or weak (probability 50%). Assume these cash flows occur at the year ends with the first of them occurring three years from now. PJP's cost of capital is 10%. Assume investors are risk neutral.
a) Construct a decision tree and determine the expected
b) Assume that PJP can pay another firm to carry out the first two stages and report their findings to PJP two years from now. What is the maximum amount PJP should pay for this?
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