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Ross5eChap09sm - Chapter 9 Risk Analysis Real Options and...

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Chapter 9: Risk Analysis, Real Options, and Capital Budgeting 9.1 Calculate the NPV of the expected payoff for the option of going directly to market. NPV(Go Directly) = C Success (Prob. of Success) + C Failure (Prob. of Failure) = $20,000,000 (0.50) + $5,000,000 (0.50) = $12,500,000 The expected payoff of going directly to market is $12,500,000. The test marketing requires a $2 million cash outlay. Choosing the test marketing option will also delay the launch of the product by one year. Thus, the expected payoff is delayed by one year and must be discounted back to year 0. NPV(Test Market) = –C 0 + [C Success (Prob. of Success)] / (1+r) + [C Failure (Prob. of Failure)] / (1+r) = –$2,000,000 + [$20,000,000 (0.75)] / (1.15) + [$5,000,000 (0.25)] / (1.15) = $12,130,434.78 The expected payoff of test marketing the product is $12,130,434.78. Sony should go directly to market with the product since that option has the highest expected payoff. 9.2 Calculate the NPV of each option. The manager should pursue the option with the highest NPV. NPV(Go Directly) = C Success (Prob. of Success) = $1,200,000 (0.50) = $600,000 The NPV of going directly to market is $600,000. NPV(Focus Group) = C 0 + C Success (Prob. of Success) = –$120,000 + $1,200,000 (0.70) = $720,000 The NPV when conducting a focus group is $720,000. NPV(Consulting Firm) = C 0 + C Success (Prob. of Success) = –$400,000 + $1,200,000 (0.90) = $680,000 The NPV when hiring a consulting firm is $680,000. The firm should conduct a focus group since that option has the highest NPV. Answers to End–of–Chapter Problems B–103
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9.3 The company should analyze both options, and choose the option with the greatest NPV. So, if the company goes to market immediately, the NPV is: NPV = CF Success (Prob. of Success) + CF Failure (Prob. of Failure) NPV = $30,000,000(0.55) + $3,000,000(0.45) NPV = $17,850,000.00 Customer segment research requires a $1 million cash outlay. Choosing the research option will also delay the launch of the product by one year. Thus, the expected payoff is delayed by one year and must be discounted back to year 0. So, the NPV of the customer segment research is: NPV= C 0 + {[CF Success (Prob. of Success)] + [CF Failure (Prob. of Failure)]} / (1 + r) NPV = –$1,000,000 + {[$30,000,000 (0.70)] + [$3,000,000 (0.30)]} / 1.15 NPV = $18,043,478.26 Graphically, the decision tree for the project is: The company should undertake the market segment research since it has the largest NPV. Answers to End–of–Chapter Problems B–104 Start Research No Research $18.0435 million at t = 0 $17.85 million at t = 0 Success Failure Success Failure $30 million at t = 1 (26.087 million at t = 0) $3 million at t = 1 (2.6087 million at t = 0) $30 million at t = 0 $3 million at t = 0
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9.4 Carl should have taken the $7,000. Expected return for 1% of movie profits is $3,952. Since only good scripts are made into movies and only a good movie would make a profit: (13% x 32% x $9.5 mil x 1%) Movie studio decision tree: 9.5 Recommend the strategy that has the highest NPV. NPV(Lower Prices) = C Success (Prob. of Success) + C Failure (Prob. of Failure) = –$1,700,000 (0.60) – $2,000,000 (0.40) = –$1,820,000 NPV(Lobbyist) = C 0 + C Success (Prob. of Success) + C Failure (Prob. of Failure) = –$950,000 – $0 (0.77) – $2,500,000 (0.23) = –$1,525,000 The CFO should hire the lobbyist since that option has the highest NPV.
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