1) You are given the information on the best guess of related outcomes for the project. Initial cash outlay for developing and market testing product over next year IS $70M. Following the test, company will spend another $400M to put productive capabilities in place at the end of the year. If the test is successful, which is expected to have the probability of= 0.8, expected annual cash flows will be $150M for 5 years. If test fails, expected annual cash flows will be= $50M for five years. The discount rate is 12%.
(a) find out the NPV of this project at time 0 supposing that project will be implemented in spite of of outcome of the test. Given that value at the end of year of the five-year $150M annuity is $540.72M, and that of five-year $50M annuity is $180.24M.
(b) Let us say, you are given a option to improve by building the better production facility at the cost of $500M if test fails. Upgraded facility is expected to produce annual cash flows of= $100M for 5 years. Note that base facility and cash flows estimates will apply if the test is successful. find out the value of option to improve at time 0.