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 their product line. The company is currently considering two options. The first is a small facility that it could build at a cost of $7 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 $14 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $12 million. Were demand to be low, the company would expect $13 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $17 million. In either case, the probability of demand being high is .50, and the probability of it being low is .50. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new products.

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.)

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 $7 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 $14 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $12 million. Were demand to be low, the company would expect $13 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $17 million. In either case, the probability of demand being high is .50, and the probability of it being low is .50. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new products.

Explanation / Answer

1. Small Facility NPV = -7 + (0.5*11 + 0.5*14) = 5.5 million dollars (discounted revenues are weighted average based on their probablity)

2. Large Facility NPV = -12 + (0.5*13 + 0.5*17) = 3 million dollars (discounted revenues are weighted average based on their probablity)

3. Do Nothing NPV = 0 million dollars (as no new dollar revenue streams are generated)

b. Based on the NPV, the best decision to help Expando is to build a small facility as it genrates the highest NPV.

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