\"A corporation is trying to decide whether to buy the patent for a product desi

Question

"A corporation is trying to decide whether to buy the patent for a product designed by another company. The decision to buy will mean an investment of $6.8 million, and the demand for the product is not known. If demand is light, the company expects a return of $2.01 million each year for the first three years and no return in the fourth year. If demand is moderate, the return will be $2.83 million each year for four years, and high demand means a return of $4.73 million each year for four years. It is estimated the probability of a high demand is 0.55, and the probability of a light demand is 0.17. The firm's interest rate is 14.8%.
Calculate the expected present worth of the patent. Express your answer in millions of dollars. For example, if the answer is $12.3 million, enter 12.3. (All figures represent after-tax values.)"

Explanation / Answer

interest rate = 14.8%

Light demand:

PW = -6.8 + 2.01/(1 + 14.8%) + .. + 2.01/(1 + 14.8%)3 = - $2.2 mn

Moderate demand:

PW = -6.8 + 2.83/(1 + 14.8%) + .. + 2.83/(1 + 14.8%)4 = $1.31 mn

High demand:

PW = -6.8 + 4.73/(1 + 14.8%) + .. + 4.73/(1 + 14.8%)4 = $6.76 mn

Expected present worth = 0.17 x -2.2 + 0.28 x 1.31 + 0.55 x 6.76 = 3.71

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