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A company has to decide whether to invest money in the development of a microbiological product. The company’s research director has estimated that there is a 60% chance that a successful development could be achieved in two years. However, if the product had not been successfully developed at the end of this period, the company would abandon the project, which would lead to a loss in present value terms of $3 million. Present value is designed to take the company’s time preference for money into account. In the event of a successful development a decision would have to be made on the scale of production. The returns generated would depend on the level of sales which could be achieved over the period of the product’s life. For simplicity, these have been categorized as either high or low. If the company opted for large volume production and high sales were achieved, then net returns with a present value of $6 million would be obtained. However, large-scale production followed by low sales would lead to net returns with a present value of only $1 million. On the other hand, if the company decided to invest only in small-scale production facilities then high sales would generate net returns with a present value of $4 million and low sales would generate net returns with a present value of$2 million. The company’s marketing manager estimates that there is a 75% chance that high sales could be achieved. [6 Marks] (a) Construct a decision tree to represent the company’s decision problem. (b) Assuming that the company’s objective is to maximize its expected returns, determine the policy that it should adopt. (c) There is some debate in the company about the probability that was estimated by the research director. Assuming that all other elements of the problem remain the same, determine how low this probability would have to be before the option of not developing the product should be chosen. (d) Before the ?nal decision is made the company is taken over by a new owner, who has the utilities shown below for the sums of money involved in the decision. (The owner has no interest in other attributes which may be associated with the decision such as developing a prestige product or maintaining employment.) What implications does this have for the policy that you identi?ed in (b) and why? Present vaule of net returns New owner’s utility -$3m 0 $0m 0.6 $1m 0.75 $2m 0.85 $4 0.95 $6 1.0
Cheeseburger and Taco Company purchases 12,349 boxes of cheese each year. It costs $12 to place and ship each order and $4.62 per year for each box held as inventory. The company is using Economic Order Quantity model in placing the orders. What is t..
In the report center under customers & receivables all of the following sections are included except:
A(n) seven-year bond has a yield of 8% and a duration of 7.212 years. If the bond's yield increases by 40 basis points, what is the percentage change in the bond's price?
Mega stock is expected to grow at 11% in year 1 and year 2, 10% in year 3, 8 % in year 4 and then grow at a constant rate of 4% in the years that follow. The required rate of return (Rs) equals 7%. The company will pay a Dividend at the end of year 1..
Determine the Payback period, NPV and IRR for both project A and B (show work). Which Project would you select and why? Be specific. Project A will require an initial investment of $ 200,000 and Project B will require and initial investment of $ 325,..
Over the past five years, a stock produced returns of 14%, 22%, -16%, 2%, and 10%. What is the probability that an investor in this stock will NOT lose more than 8% nor earn more than 21% in any one given year?
Ten years ago your father purchased for you a 25-year $1,000 bond with a coupon rate of 7%. You now wish to sell the bond and learn that the current discount rate to use is 5%. What price should you receive for the bond?
Hook Industries' capital structure consists solely of debt and common equity. It can issue debt at rd = 8%, and its common stock currently pays a $3.00 dividend per share (D0 = $3.00). The stock's price is currently $26.00, its dividend is expected t..
Project K costs $62,307.93, its expected cash inflows are $14,000 per year for 9 years, and its WACC is 11%. What is the project's IRR?
A friend offers to give you 10 payments of $1,500 at annual time periods zero through 10 except year three if you give him $13,500 at year three. What is the NPV of this opportunity if i=20%?
Consider the following two mutually exclusive projects: What is the NPV of Projects X and Y at discount rates of 0%, 15%, and 25%?
You have purchased a call option (100 contracts) on Mercer Corporation common stock. The option has an exercise price of $20.00 and Mercer’s stock currently trades at $20.00. Calculate your net profit on the option if Mercer Corporation’s stock price..
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