Question

You own a factory that can produce up to 1M widgets per year. Each widget costs $1.50 to produce. The market price of a widget will be either $2.50 (good economy) or $1.75 (bad economy) next year. All production, costs, and revenues occur at the end of the year. If you can wait until the end of the year to decide to produce or not, construct the set of possible payoffs at time 1 of the factory. NOTE: Do not attempt to find the value of the project. 2. Suppose you have the ability to produce a high-end version of the widget, which will cost $2.00 to make. It will sell for either $3.75 (good economy) or $1.50 (bad economy) next year. Alternatively, you could produce the normal widgets described in the previous problem. You can only produce one type of widget, but you can wait until the end of the year to decide which type to produce. Construct the time 1 payoff of the factory for the good and bad economy.

Answer 1

Expected units to be sold	1,000,000
Price per unit	2.5	1.5
Revenue for period 1	2,500,000	1,500,000
Cost of production @1.5 per unit	1,500,000	1,500,000
Payoff	1,000,000	-
Price of per unit of the high end	3.75	1.5
Revenue for period 1	3,750,000	1,500,000
Cost of production @2 per unit	2,000,000	2,000,000
Payoff	1,750,000	(500,000)

It can be ascertained form above calculation that at times of good economy, the standard widget produced by the factory will fetch out a payoff of $1m while in bad economy, it will be break even

Furthermore, for the high end project produced by the factory, it will fetch out a payoff of $1.75m while a loss of $500k in bad economy