Expando, Inc., is considering the possibility of building an additional factory
ID: 349462 • Letter: E
Question
Expando, Inc., is considering the possibility of building an additional factory that would produce a new addition to their product line. The company is currently considering two options. The first is a small facility that it could build at a cost of $6 million. If demand for new products is low, the company expects to receive $10 million in discounted revenues (present value of future revenues) with the small facility. On the other hand, if demand is high, it expects $12 million in discounted revenues using the small facility. The second option is to build a large factory at a cost of $9 million. Were demand to be low, the company would expect $10 million in discounted revenues with the large plant. If demand is high, the company estimates that the discounted revenues would be $14 million. In either case, the probability of demand being high is 0.40, and the probability of it being low is 0.60. Not constructing a new factory would result in no additional revenue being generated because the current factories cannot produce these new products.
a. Calculate the NPV for the following: (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers in millions rounded to 1 decimal place.)
Small facility million Do nothing million Large facility millionExplanation / Answer
Here to calculate NPV we need to calculate the expected monetary returns of each decision.
Small facility:
cost = 6 million
demand low = 10 million
demand high = 12 million
expected value of small facility = propability of demand low*10 million + probability of demand high*12 million - cost
= 0.6*10 + 0.4*12 - 6
= 6 + 4.8 -6
= 4.8 million
NPV of small facility is 4.8 million
Large facility:
cost = 9 million
demand low = 10 million
demand high = 14 million
expected value of large facility = propability of demand low*10 million + probability of demand high*14 million - cost
= 0.6*10 + 0.4*14 - 9
= 6 + 5.6 - 9
= 2.6 million
NPV of large facility is 2.6 million
NPV of doing nothing is 0.
Small facility 4.8 million Do nothing 0 million Large facility 2.6 millionRelated Questions
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