Expando, Inc., is considering the possibility of building an additional factory
ID: 392663 • 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 $14 millon in discounted revenues using the small facility. The second option is to build a large factory at a oost of $8 million. Were demand to be low, the company would expect $14 million in discounted revenues with the large 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 "o" wherever required. Enter your answers in millions rounded to 1 declmal place.) 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 0.60, and the probability of it being low is 0.40. Not constructing a new Plans NPV Small facility Do nothing Large facility illion illion illion b. The best declsion to help Expando is to build the small facility to build the large tacility. lo do nothingExplanation / Answer
Net present Value ( NPV ) of any plan can be formulated as per following :
NPV
= Probability of low demand x Revenue earned in situation of low demand + Probability of high demand x Revenue earned in situation of high demand – Cost of building the facility
= 0.4 x Revenue earned in situation of low demand + 0.6 x Revenue earned in situation of high demand – Cost of building the facility ( remarks: since probability of low demand is 0.4 and probability of high demand 0.6)
On basis of data provided and as per the formula written above ,
NPV of the small facility
=0.4 x $ 9 million + 0.6 x $14 million - $ 6 million
= $3.6 million + $8.4 million - $6 million
= $12 million - $6 million
= $6 million
NPV of the large facility
= 0.4 x $ 14 million + 0.6 x $15 million - $ 8 million
= $5.6 million + $ 9 million - $ 8 million
= $ 6.6 million
Since no revenue is earned and no cost is incurred under “Do nothing”,
NPV for Do Nothing = 0
Plan
NPV
Small facility
$ 6 million
Do nothing
0
Large facility
$6.6 million
Plan
NPV
Small facility
$ 6 million
Do nothing
0
Large facility
$6.6 million
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