Expando, Inc., is considering the possibility of building an additional factory
ID: 361003 • 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 $6 million. If demand for new products is low, the company expects to receive $11 million in discounted revenues (present value of future revenues) with the small facility. On the other hand, if demand is high, it expects $12 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $11 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 $16 million. In either case, the probability of demand being high is 0.40, and the probability of it being low is 0.60. 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.) Plans NPV Small facility $ million Do nothing million Large facility million
Explanation / Answer
Net present value of any option
= Discounted revenue adjusted for probabilities under low and high demand – Cost to build
= ( Probability of high demand x Discounted revenue under high demand + Probability of low demand x Discounted revenue under low demand ) – Cost to build
= ( 0.4 x Discounted revenue under high demand + 0.6 x Discounted revenue under high demand ) – Cost to build
Therefore,
NPV of the small facility , $ million
= ( 0.4 x 12 + 0.6 x 11 ) - 6
= 4.8 + 6.6 - 6
=11.4 - 6
= 5.4
Similarly , NPV for the large facility
= ( 0.4 x 16 + 0.6 x 12 ) – 11
= 6.4 + 7.2 - 11
= 13.6 - 11
= 2.6
Not constructing any factory would not have any revenue as well as cost items. Hence , its NPV will be Zero
PLAN
NPV
Small facility
5.4
Million
Do nothing
0
Million
Large facility
2.6
Million
PLAN
NPV
Small facility
5.4
Million
Do nothing
0
Million
Large facility
2.6
Million
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