A company is trying to decide investing between the two projects (A or B) shown

Question

A company is trying to decide investing between the two projects (A or B) shown on the diagram. Project A requirers an investment of $1,200,000 now; project B $200,000. There is a 60% chance the growth will be high and 40% that it will be only moderate. If the company invests in project A and the grow is high (Box I), then it must decide at the begining of next year whether to invest an additional $2,000,000 or $500,000. The returns from this investment will be realized a year later, or two years from now (i.e .Boxes VIII-XIII).

If the company invests in Project A and the growth in sales is moderate, there is 30% chance it will make $3,000,0000 (Box II) at the end of the year and 70% chance that it will make only $1,000,000 (Box III). After which the company is planning on discontinuing the project.

Project B has a lifespan of one year. If the company invests in Project B and the growth is high, there is an 80% chance that the company will make $2,000,000 (Box IV) at the end of the year and a 20% chance that it will make $1,250,000. There is no second year for this project.

If the company invests in project B and the growth is moderate, there is a 70% chance that the company will make $1,100,000 (Box VI) at the end of the year and a 30% that it will make $800,000.

The company uses an 11% discount rate.

a) Which project the company should invest in?

b) How much can the company invest in Project A and affect a change for the decision made in part (a)?

A company is trying to decide investing between the two projects (A or B) shown on the diagram. Project A requirers an investment of $1,200,000 now; project B $200,000. There is a 60% chance the growth will be high and 40% that it will be only moderate. If the company invests in project A and the grow is high (Box I), then it must decide at the begining of next year whether to invest an additional $2,000,000 or $500,000. The returns from this investment will be realized a year later, or two years from now (i.e .Boxes VIII-XIII). If the company invests in Project A and the growth in sales is moderate, there is 30% chance it will make $3,000,0000 (Box II) at the end of the year and 70% chance that it will make only $1,000,000 (Box III). After which the company is planning on discontinuing the project. Project B has a lifespan of one year. If the company invests in Project B and the growth is high, there is an 80% chance that the company will make $2,000,000 (Box IV) at the end of the year and a 20% chance that it will make $1,250,000. There is no second year for this project. If the company invests in project B and the growth is moderate, there is a 70% chance that the company will make $1,100,000 (Box VI) at the end of the year and a 30% that it will make $800,000. The company uses an 11% discount rate. Which project the company should invest in? How much can the company invest in Project A and affect a change for the decision made in part (a)?

Explanation / Answer

INVESTMENT GROWTH PROB PROFIT PROB EXPECTED VALUE A 1200000 HIGH 0.6 2000000 0.5 1000000 1200000 HIGH 0.6 500000 0.5 250000 1200000 LOW 0.4 1000000 0.7 700000 1200000 LOW 0.4 30000000 0.3 9000000 B 200000 HIGH 0.6 2000000 0.8 1600000 200000 HIGH 0.6 1250000 0.2 250000 200000 LOW 0.4 1100000 0.7 770000 200000 LOW 0.4 800000 0.3 240000 CASH INFLOW PV OF CASH INFLOW CASH OUTFLOW NPV PROJECT A 4630000 4171171 1200000 2971171 PROJECT B 1514000 1363964 200000 1163964 WE CAN SEE THAT, NPV IS GRETER IN PROJECT A, HENCE IT IS TO BE OPTED.

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