Genz has come up with a new product prototype and is ready to go ahead with pilot production and test marketing. The pilot pro- duction and test marketing phase will last for one year and cost $500,000. Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new product. If the test-marketing phase is successful, then Genz will invest $3 million in year one to build a plant that will generate expected annual after tax cash flows of $400,000 in perpetuity beginning in year two. If the test mar- keting is not successful, GenZ can still go ahead and build the new plant, but the expected annual after tax cash flows would be only $200,000 in perpetuity beginning in year two. Genz has the option to stop the project at any time and sell the prototype product to an overseas competitor for $300,000. GenZ's cost of capital is 10%. a) Assuming that GenZ has the ability to sell the prototype in year one for $300,000, draw a decision tree detailing the project de- scribed above. b) Assuming that GenZ has the ability to sell the prototype in year one for $300,000, what is the NPV of the Project ? c) Assuming that Genz does not have the ability to sell the pro- totype in year one, what is the NPV of the Project ? d) Look at the decision tree below and use your knowledge of deci- sion trees to create your own story that explains what is depicted. You may invent the name of a company, and a product. De- scribe what is happening to this product in the various stages of the process displayed by the decision tree. There is no need to work out any NPV figures. (max 200 words)
Genz has come up with a new product prototype and is ready to go ahead with pilot production and test marketing. The pilot pro- duction and test marketing phase will last for one year and cost $500,000. Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new product. If the test-marketing phase is successful, then Genz will invest $3 million in year one to build a plant that will generate expected annual after tax cash flows of $400,000 in perpetuity beginning in year two. If the test mar- keting is not successful, GenZ can still go ahead and build the new plant, but the expected annual after tax cash flows would be only $200,000 in perpetuity beginning in year two. Genz has the option to stop the project at any time and sell the prototype product to an overseas competitor for $300,000. GenZ's cost of capital is 10%. a) Assuming that GenZ has the ability to sell the prototype in year one for $300,000, draw a decision tree detailing the project de- scribed above. b) Assuming that GenZ has the ability to sell the prototype in year one for $300,000, what is the NPV of the Project ? c) Assuming that Genz does not have the ability to sell the pro- totype in year one, what is the NPV of the Project ? d) Look at the decision tree below and use your knowledge of deci- sion trees to create your own story that explains what is depicted. You may invent the name of a company, and a product. De- scribe what is happening to this product in the various stages of the process displayed by the decision tree. There is no need to work out any NPV figures. (max 200 words)
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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Transcribed Image Text:Genz has come up with a new product prototype and is ready to
go ahead with pilot production and test marketing. The pilot pro-
duction and test marketing phase will last for one year and cost
$500,000. Your management team believes that there is a 50%
chance that the test marketing will be successful and that there will
be sufficient demand for the new product. If the test-marketing
phase is successful, then GenZ will invest $3 million in year one to
build a plant that will generate expected annual after tax cash flows
of $400,000 in perpetuity beginning in year two. If the test mar-
keting is not successful, Genz can still go ahead and build the new
plant, but the expected annual after tax cash flows would be only
$200,000 in perpetuity beginning in year two. GenZ has the option
to stop the project at any time and sell the prototype product to an
overseas competitor for $300,000. GenZ's cost of capital is 10%.
a) Assuming that GenZ has the ability to sell the prototype in year
one for $300,000, draw a decision tree detailing the project de-
scribed above.
b) Assuming that GenZ has the ability to sell the prototype in year
one for $300,000, what is the NPV of the Project ?
c) Assuming that Genz does not have the ability to sell the
totype in year one, what is the NPV of the Project ?
pro-
d) Look at the decision tree below and use your knowledge of deci-
sion trees to create your own story that explains what is depicted.
You may invent the name of a company, and a product. De-
scribe what is happening to this product in the various stages of
the process displayed by the decision tree. There is no need to
work out any NPV figures. (max 200 words)
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