Question

Problem 5-8

Expando, Inc., is considering the possibility of building an additional factory that would produce a new addition to their product line. The company is currently considering two options. The first is a small facility that it could build at a cost of $7 million. If demand for new products is low, the company expects to receive $10 million in discounted revenues (present value of future revenues) with the small facility. On the other hand, if demand is high, it expects $14 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 $16 million. In either case, the probability of demand being high is 0.30, and the probability of it being low is 0.70. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new products.

a. Calculate the NPV for the following: (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers in millions rounded to 1 decimal place.)

b. The best decision to help Expando is  

• to do nothing.

• to build the small facility.

• to build the large facility.

Answer 1

V how demand $10 million Small egh - $7 million demand 0.3 $14 million $14 - $10 million harge how Demand $12 million gh demand 03 $16 million a)APV (Small facility) = 0-7X10 +0-3X14 -+ = $42 million NP faulty) = 0-7x12+ 0-3X 16-10 = $3.2 million

b)

NPV is higher for small facility. The best decision is

to build the small facility