Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $27,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $7,000 per year for 2 years. Fethe's cost of capital is 13%. Do not round intermediate calculations. a. What is the expected NPV of the project? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest dollar. 24 b. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Write out the decision tree. Note: The franchise fee payment at the end of Year 2 is known, so it should be discounted at the risk-free rate, which is 5%. Select the correct decision tree. B r= 5% r= 13% 1 3 40% Prob 20.000 7.000 40% Prob 20 000 27.000 27.000 27.000 27.000 Good 7.000 7.000 7.000 Good - 20.000 (r = 13%) - 20.000 (r = 5%) Bad Bad 60% Prob. 60% Prob. 20.000 7.000 7.000 20.000 27.000 27.000 D
Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $27,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $7,000 per year for 2 years. Fethe's cost of capital is 13%. Do not round intermediate calculations. a. What is the expected NPV of the project? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest dollar. 24 b. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Write out the decision tree. Note: The franchise fee payment at the end of Year 2 is known, so it should be discounted at the risk-free rate, which is 5%. Select the correct decision tree. B r= 5% r= 13% 1 3 40% Prob 20.000 7.000 40% Prob 20 000 27.000 27.000 27.000 27.000 Good 7.000 7.000 7.000 Good - 20.000 (r = 13%) - 20.000 (r = 5%) Bad Bad 60% Prob. 60% Prob. 20.000 7.000 7.000 20.000 27.000 27.000 D
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell
the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $27,000 per year for 2 years. If demand
cash flows will be $7,000 per year for 2 years. Fethe's cost of capital is 13%. Do not round intermediate calculations.
s bad (60% probability), then the net
a. What is the expected NPV of the project? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest dollar.
24
b. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In
this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Write out
the decision tree. Note: The franchise fee payment at the end of Year 2 is known, so it should be discounted at the risk-free rate, which is 5%.
Select the correct decision tree.
A
B
r= 5%
1
r= 13%
1
2
3
4
40% Prob.
40% Prob
Good
- 20.000 27.000 27,000 27.000 27.000
20.000 (r = 13%)
20.000 7.000
7.000
7.000 7.000
Good
- 20.000 (r = 5%)
Bad
Bad
60% Prob
60% Prob.
20.000 7.000
7.000
20.000 27.000 27.000
r= 13%
r = 13%
1
2
3
4
1
3
40% Prob.
40% Prob.
Good
20.000 27.000 27.000 27.000 27.000
20.000 27.000 27.000 27.000 27.000
Good
20.000 (r = 5%)
- 20.000 (r = 5%)
Bad
Bad
60% Prob
60 % Prob.
20.000 7.000
7.000
7,000 7.000
20.000 7.000
7.000
The correct graph is -Select-
Use decision-tree analysis to calculate the expected NPV of this project, including the option to continue for an additional 2 years. Negative values, if any, should be
indicated by a minus sign. Round your answer to the nearest dollar.
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