Question

5. Management of Seagate Technologies is considering the investment of $350 million in manufacturing capacity, start-up costs, and net working capital to exploit a unique new technology. The effectiveness of the new technology-developed at a total cost of $80 million - remained highly uncertain... During the project's expected fifteen-year life, free cash flows were forecast at anywhere from $0 per year to $98 million per year. Management believed that the effectiveness of the technology would be known by the end of year one. The expected annual free cash flow was $49 million. Estimated Probability Free Cash Flow Years 1-15 Outcome Highly successful Most likely Worst case .17 $98 million .66 X $49 million $0 million Expected annual free cash flow = = = = $16.66 $32.34 $0 $ 49 million .17

Answer 1

Worst case scenario cash flows: CF0 = -350; CF1 = 170

Note: Technology development costs are sunk costs and so, won't be considered for NPV analysis.

NPV = -350 + 170/(1+13%) = -199.56 mn

Most likely scenario cash flows: CF0 = -350; CF1 to CF15 = 49

NPV = -350 + 49*PVIFA(13%,15) = -33.34 mn

Highly successful scenario cash flows: CF0 = -350; CF1 = -350 + 98 = -252; CF2 to CF15 = 98

NPV = -350 -252/(1+13%) + [98*PVIFA(13%,14)]/(1+13%) = -26.42 mn

Expected NPV = sum of probability weighted NPVs

= (17%*-26.42) + (66%*-33.34) + (17%*-199.56) = -60.42 mn

This investment should not be made as it has a negative NPV.