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10) Kingston's cost of capital is 10%. Kingston Industries has come up with a new mountain bike prototype and is ready to launch the business

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10) Kingston's cost of capital is 10%. Kingston Industries has come up with a new mountain bike prototype and is ready to launch the business by investing $3 million to build a plant in year one and begin sales in the following year. Your management team believes that there is a 50% chance that there will be sufficient demand for the new mountain bike, in which case the business will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two (so a value of $4 million based on the WACC of 10%) and a 50% chance the demand will be softer and the expected annual after-tax cash flows would be only $150,000 in perpetuity beginning in year two (so a value of $1.5 million based on the WACC of 10%). What is the expected value of the business before considering the upfront capital investment? What is the net value of the project after considering the capital investment (you do not need to do any discounting of cash flows)? Should the company proceed with the project based on the above analysis? Now assume that Kingston can spend $300,000 for one year to do some pilot production and test marketing to determine whether the product will be successful. Again, there is a 50% chance that the test marketing will be successful and there will be sufficient demand for the new mountain bike. If the test is successful, then Kingston will build the plant for a cost of $3 million and proceed with the project. Otherwise, Kingston will not build the plant. In this case, your potential cash flows as follows: Year 0: -$300,000 for the test Year 1: 50% chance of a successful project with a net value of $1,000,000 (spend S3 million to end up with a business worth $4 million) 50% chance of 0 (don't proceed after the test) What is the NPV of the project now (you will have to discount your year 1 value by one year at the WACC)? Should you do the project now (ie, conduct the test) based on the above analysis

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