1.An automobile manufacturer is planning to enter a new market with a new car model. It will take two years of R&D to develop the new model. The first year of development requires an investment of $50M. The second year of product development requires $150M. If the manufacturer does not initiate product development now, it will miss the market opportunity. The manufacturer does not know the market potential in advance. It believes that there is a 50% chance that the demand will be high and it can earn profits of $100M each year for five years after product launch. It also believes that there is a 50% chance that the demand will be low and it can earn profits of $20M each year for five years after launch. The opportunity cost of capital is 20% (i.e., this is its discount rate to calculate the net present value of future cash flows).

a.Should the manufacturer invest in product development?

b.Suppose the manufacturer could obtain market research that will accurately predict whether demand will be high or low, what is the value of this market research to the manufacturer?

c. Suppose by making the initial investment in the first year, the manufacturer can learn more about the market and accurately predict whether demand will be high or low, should it make the initial investment? (The manufacturer can decide whether or not to continue product development after the first year).