ring a new line of molded foam sports novelty items to be marketed to a uct plac
ID: 2787545 • Letter: R
Question
ring a new line of molded foam sports novelty items to be marketed to a uct placed with the retailer, NN must first produce prototype products to pitch to the retailer's sports buyer. The prototypes would cost $10,000 at t-0 NN's development team believes that there is a 70% chance that the buyer will approve of the pro company would need to spend $75,000 at t-1 to make production molds. If the buyer rejecs totypes a nd the project would be abandoned. Once the produc well, N production sell well in the test stores tion molds are in place, the buyer will place the products in a few test stores. If the product sells N will invest another $100,000 at t-2 to ramp up production capacity for a national rollout. If not, the molds will be sold at t-2 for $25,000. NN believes that there is a 60% chance that the products will Once the national rollout occurs, there Novelties will have a cash inflow of $900,000 at t-3. If the products are less popular, the cash inflow is expected is a 45% chance that the foam novelty products are a hit and Noah's to be $200,000. NN uses a WACC of 15% for all projects. Should the company spend the S 10,000 to create the prototypes? (10 points)Explanation / Answer
t Cost Probability Sunk cost 0 -10000 30% -10000 1 -75000 70% 40% -50000 2 -100000 60% 3 900000 45% 55% 200000 WACC 15% Case 1 Best case scenario, Product hit the market well and national roll out is success. t Cost DF PV Probability 0 -10000 1.00 -10,000 100% -10,000 1 -75000 0.87 -65,217 70% -45,652 2 -100000 0.76 -75,614 60% -45,369 3 900000 0.66 5,91,765 45% 2,66,294 1,65,273 Case 2 If project gets abonded at t1 after spending 10,000, Protype got rejected t Cost DF PV Probability 0 -10000 1.00 -10,000 30% -3,000 -3,000 Case 3 If project gets abonded after investing $75,000 at t2 t Cost DF PV Probability 0 -10000 1.00 -10,000 100% -10,000 1 -75000 0.87 -65,217 70% -45,652 2 25000 0.76 18,904 40% 7,561 -48,091 Case 3 If national roll out doesnot work well t Cost DF PV Probability 0 -10000 1.00 -10,000 100% -10,000 1 -75000 0.87 -65,217 70% -45,652 2 -100000 0.76 -75,614 60% -45,369 3 200000 0.66 1,31,503 55% 72,327 -28,694 Overall Return Sum of all above scenarios 85,489 Since the result is positive, the Company should go ahead with making Prototype
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