# Chap9 - Chapter 9 Risk Analysis Real Options and Capital...

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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) 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 End-of-Chapter Problems B-103

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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, B&B should go directly to market. 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 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
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 (25.00 5.00)(1 .25) 307,120.89 20,474.73 15 c PVCCATS c EAC Fixed ts T EAC Breakeven Saleprice iable ts T Breakeven Breakeven units + - - = - - + - - = - - = = The company has a present value break even amount of 20,475 toys. 9.12 Use formula for present value break even calculation. But first, calculate the EAC PVCCATS as follows: 5 300,000(0.30)(0.40) 1.04 10,000(0.30)(0.4) 1 [ ] [ ] 0.08 0.30 1.08 0.08 0.30 (1.08) \$91,228.07 2,149.21 \$89,078.86 PVCCATS x x = - + + = - = EAC PVCCATS = \$89,078.86 / 5 0.08 A = 89,078.86 / 3.9927 = \$22,310.43 EAC of the investment is: [300,000 – 10,000/(1.08) 5 ] / 3.9927 = \$ 73,432.56 Answers to End-of-Chapter Problems B-105

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cos (1 ) ( var cos )((1 ) 73,432.56 100,000(1 0.4) 22,310.43 (60.00 8.00)(1 .4) 111,122.13 3,561.61 31.20 c PVCCATS c EAC Fixed ts T EAC Breakeven Saleprice iable ts T Breakeven Breakeven units + - - = - - + - - = - - = = The company has a present value break even amount of 3,562 pair of shoes..
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