Expando, Inc., is considering the possibility of building an additional factory
ID: 2384413 • Letter: E
Question
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 $9 million in discounted revenues (present value of future revenues) with the small facility. On the other hand, if demand is high, it expects $13 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 $11 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 .20, and the probability of it being low is .80. 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 build the small facility. to do nothing. to build the large facilityExplanation / Answer
Demand Low High Cost of Facility 7 9 Present Value of Revenues 9 13 Small Plant Low High Total Probability of Demand 0.80 0.20 1.00 Present Value of Discounted cash flows 9 13 22.00 Expected Revenue 7.2 2.6 9.80 Profitability Index = 9.80/7.00=1.40 Large Plant: Low High Total Probability of Demand 0.80 0.20 1.00 Present Value of Discounted cash flows 11 14 25.00 Expected Revenue 8.8 2.8 11.60 Profitability Index = 11.60/9.00=1.29 Answer to Q.a) Net Present Value of Small plant = 9.80-7 = 2.80 million Net Present Value of Large plant = 11.60-9 = 2.60 million Answer to Q.b) Build a small plant that will give highest NPV Value with a higher Profitability index.
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