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PROBLEM 13-5 First Project Problem 5 PV (good state) Investment 150 Year 1 15 prob = 50% Year 2 15 Year 3 15 0 0 -100 prob = 50% PV (bad state) NPV 0...

Simple Investment Strategy- Staged Investments – You have been retained to evaluate a major investment for a technology company. The cost of the project is $100 million. If the project is successful, it will generate expected profits of $15 million per year forever, which has a present value of $150 million. However, there is a 50% chance that the project will be a complete failure, in which case it will generate no cash flows. Moreover, if the project is successful, there will be a follow-on project that can be initiated the following year. The follow-on project will have a cost of $1 billion, and if things go well (probability of 50%), it will generate expected cash flows of $150 million per year that last forever and result in a value of $1.5 billion (in year 1 dollars). If the follow-on project is not successful, it will result in a stream of cash flows with a present value of $900 million. Should the initial project be taken? Explain your recommendation in commonsense terms to your boss, who is not a “techie”.
PROBLEM 13-5 Problem 5 First Project Year 1 Year 2 Year 3 PV (good state) 150 15 15 15 prob = 50% Investment -100 prob = 50% PV (bad state) 0 0 0 0 NPV Follow-On Opportunity (Year 1) Year 2 Year 3 Year 4 PV 1500 150 150 150 prob = 50% Investment -1000 prob = 50% PV 900 90 90 90 NPV Solution Legend = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output
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Finance-8083402.xls

PROBLEM 13-5
First Project Problem 5
PV (good state)
Investment 150 Year 1
15
prob = 50% Year 2
15 Year 3
15 0 0 -100
prob = 50% PV (bad state)
NPV 0
-33.04 0 Follow-On Opportunity (Year 1)
PV...

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