Expando, Inc., is considering the possibility of building an additional factory

Question

Expando, Inc., is considering the possibility of building an additional factory that would produce a new addition to its 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 the new products is low, the company expects to receive $10 million in discounted revenues (present value of future revenues) wit 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 $9 million. Were demand to be low, the company would expect $10 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 0.4, and the probability of it being low is 0.6. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new porducts. If the small facility is built, what is the expected revenue (in millions of dollars)?

Explanation / Answer

Expected revenue in small factory

EV = [10x0.6+ 12x0.4 ] -6

= 6+4.8 -6 = 4.8 million dollars.

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