Expando, Inc., is considering the possibility of building an additional factory
ID: 342912 • 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 $5 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 $14 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $10 million. Were demand to be low, the company would expect $12 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $15 million. In either case, the probability of demand being high is 0.50, and the probabilty of i being low is 0.50. 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"" wherever required. Enter your answers In millions rounded to 1 decimal place.) Plans Small faclility Do nothing Large facility million million million b. The best decision to help Expando is to buld the small facility to build the large facility. to do nothing.Explanation / Answer
Cost of building a small facility = $5 million
Discounted revenues from the product when the demand is low from the small facility would be = $ 9 million
Discounted revenues from the product when the demand is high from the small facility would be = $ 14 million
Cost of building a large facility = $10 million
Discounted revenues from the product when the demand is low from the large facility would be = $ 12 million
Discounted revenues from the product when the demand is high from the large facility would be = $ 15 million
NPV or Net present value of -
Small facility, low demand = Cash inflow - Cash outflow = 9-5 = $ 4 million
Small facility, high demand = Cash inflow - Cash outflow = 14-5 = $ 9 million
Large facility, low demand = Cash inflow - Cash outflow = 12-10 = $ 2 million
Large facility, high demand = Cash inflow - Cash outflow = 15-10 = $ 5 million
As the probability of high and low demand is 0.50, the net NPV of small factory =
(probabilty of low demand)*NPV (small factory, low demand) + (probabilty of high demand)*NPV (small factory, high demand)
= 0.50* 4 + 0.50 *9
= 6.5 million
The net NPV of large factory =
(probabilty of low demand)*NPV (large factory, low demand) + (probabilty of high demand)*NPV (large factory, high demand)
= 0.50 *2 + 0.50 *5
= 3.5 million
NPV of no change would be equal to 0 as no investment would be made.
ans b) The best decision to help Expando would be to invest in a small facility as can be seen by the higher value of net present value. It shows that there would be higher profits in the future if the company invests in the small facility.
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