Question

A coperation is trying to decide whether or not to buy the patent for a product designed by another company. The decision to buy means of investment of 8 million...

A corporation is trying to decide whether or not to buy the patent for a product designed by another company. The decision to buy means an investment of $8 million and the demand for the product is not known. If demand is light, the company expects a return of $1.3 million each year for 3 years (assume no cost or revenue related to this project afterward). If the demand is moderate the return will be $2.5 million each year for 4 years and a high demand means a return of $4 million each year for 4 years (all figures represent after-tax values). It is estimated the probability of a high demand is 0.4 and the probability of a light demand is 0.2. The firms interest rate (risk- free) is 10%. Calculate: Note: please answer in dollars, NOT in million dollars 1. Expected present value (3 marks) Your answer is $ 2. Standard Deviation of the NPV (2 decimals, 2 mark) Your answer is $ 3. Coefficient of Variation of NPV (2 decimals, 2 mark) Your answer is $

Answer 1

1) $11802088

since the investment is $8 and the outcomes are different for different periods of time interest given 10%

when the demand is light

8*10%*3 = 24x/10 = 1.3

x₁ = 13/24

when the demand is moderate

8*10%*4 = 32x/10 = 2.5

x₂ = 25/32

when the demand is high

8*10%*4 = 32x/10 = 4

x₃ = 40/32

Expectation = summation(x_i * probability)

= x₁* 0.2 + x₂ * 0.6 + x₃ * 0.4

= 11802088 dollars

2) standard deviation = $217669

3) coefficient of variation = 217669 / 11802088

= $18443