Question

Expando, Inc. 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 $6 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 $12 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $9 million. Were demand to be low, the company would expect $10 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $14 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: (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers in millions rounded to 1 decimal place.)

Plans	NPV in millions
Small Factory
Do Nothing
Large Facility

b. The best decision to help Expando is

• to build the small facility.

• to build the large facility.

• to do nothing.

Answer 1

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revenue 2-6410 20+0 Answer: (a) Net present value of small facility with low demana and high demand: NPV= Building cost + pryent value of future = $4 million Net present value of small facility with high demand NPV = Building cost + Estimated discounted revenue on Small faulity -6+12 = $ 6 Million Net present value of small facility! NPV = Siprobability of low demand & NPV of low demand) + {probability of high demound & NPV of high demand)] = 6.6x4) + (0.4x6) 2.4 +2.4 4.8 Million Net Present Value of Somall facilily is 4.8 Million Net present value of do nothing: Net pryent value of do nothing = cash inflow & cash out How The net present value of do nothing is $0 Net present value of large facility with low demand! NPV = Building cost & Discounted revenue with large facility C-9+10 - $ 1 million INPV = Building est + Estimated discounted revenue with large facility = $5 Million | Net present of large facility NPV v=[probability of low demand x NPV of low demang]+ (Probability of high demand & NPV of high dengand)] 0.6x1) +6.4x5) = 0.6+2 - 32.6 Million The net pryent value of large facility is $2.6 Million Hence, Sneall value facility is $4.8, do nothing value is $0 The large value is $2.6 (6) the best decision for Expande would be to build the small Jauility with low and high demand, Because it has the highest net prsent value. --9+14