Question: An auto plant that costs $100 million to build can produce a line of f

Question

Question: An auto plant that costs $100 million to build can produce a line of flex fuel cars that will produce cash flows with a present value of $140 million if the line is successful but only $50 million if it is unsuccesful. You believe that the probability of success is only about %50. You learn whether the line is successful immediately after building the plant

a) Would you build the plant?

b)Suppose that the plant can be sold for $95 million to another automaker if the auto line is not succesfull. Now would you build the plant?

Explanation / Answer

a) we get expected payoff from building the plant = 0.5 x 50 + 0.5 x 140 = 95 milion only.

SO,

I WILL NOT BUILD THE PLANT.

b) IN this case, my net payoff will be : 0.5 x (50+95) + 0.5 x 140 = 142.5

as it is greater than the cost = 100 miliion.

SO, YES I WILL BUILD IN THIS CASE>

:)

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