This preview shows pages 1–4. Sign up to view the full content.
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)
T
+
[C
Failure
(Prob. of Failure)] / (1+r)
T
= $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 EndofChapter Problems
B103
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document 9.3
Recommend the strategy that has the highest NPV.
NPV(Lower Prices)
= C
Success
(Prob. of Success) + C
Failure
(Prob. of Failure)
= $1,300,000 (0.55)  $1,850,000 (0.45)
=
$1,547,500
NPV(Lobbyist)
= C
0
+ C
Success
(Prob. of Success) + C
Failure
(Prob. of
Failure)
= $800,000  $0 (0.75)  $2,000,000 (0.25)
=
$1,300,000
The CFO should hire the lobbyist since that option has the highest NPV.
9.4 Since the NPV of Research is greater than that of no research, based on expected outcomes,
Note:
Research = –1 million investment + 0.7 * (26.087)
if successful
+ 0.3 * (2.6087)
if
unsuccessful
No Research = 0.55 * (30)
if successful
+ 0.45 * (3)
if unsuccessful
Answers to EndofChapter Problems
B104
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
9.10
Use formula for present value break even calculation.
But first, calculate the
EAC
PVCCATS
as follows:
5
200,000(0.20)(0.25) 1.06
20,000(0.20)(0.25)
1
0.12 0.20
1.12
0.12 0.20
(1.12)
$29,576 $1,773
$27,803
PVCCATS
x
x
=

+
+
=

=
EAC
PVCCATS
= $27,803 /
5
0.12
A
= 27,803 / 3.60478 = $7,712.81
EAC of the investment is:
[200,000 – 20,000/(1.12)
5
] / 3.60478
= $52,333.70
cos (1
)
(
var
cos )((1
)
52,333.70 350,000(1 0.25) 7,712.81
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview. Sign up
to
access the rest of the document.
This note was uploaded on 11/02/2011 for the course ACTSC 371 taught by Professor Wood during the Fall '08 term at Waterloo.
 Fall '08
 Wood

Click to edit the document details