Question

Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $22,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $6,000 per year for 2 years. Fethe's cost of capital is 12%. Do not round intermediate calculations.

1. What is the expected NPV of the project? A negative value should be entered with a negative sign. Round your answer to the nearest dollar.
   $  
   
2. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Write out the decision tree.  Note: The franchise fee payment at the end of Year 2 is known, so it should be discounted at the risk-free rate, which is 7%..

   Use decision-tree analysis to calculate the expected NPV of this project, including the option to continue for an additional 2 years. A negative value should be entered with a negative sign. Round your answer to the nearest dollar.

Answer 1

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