Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

5. Flexibility options St. Margaret Beer Co. is looking at investing in a production facility that will require an initial investment of $500,000. The facility

5. Flexibility options St. Margaret Beer Co. is looking at investing in a production facility that will require an initial investment of $500,000. The facility will have a three-year useful life, and it will not have any salvage value at the end of the projects life. If demand is strong, the facility will be able to generate annual cash flows of $265,000, but if demand turns out to be weak, the facility will generate annual cash flows of only $135,000. St. Margaret Beer Co. thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak.

If the company uses a project cost of capital of 11%, what will be the expected net present value (NPV) of this project?

-$9,568

-$11,258

-$5,628

-$7,880

St. Margaret Beer Co. could spend $510,000 to build the facility. Spending the additional $10,000 on the facility will allow the company to switch the products they produce in the facility after the first year of operations if demand turns out to be weak in year 1.

If the company switches product lines because of low demand, it will be able to generate cash flows of $260,000 in years 2 and 3 of the project. What is the expected NPV of this project if St. Margaret Beer Co. decides to invest the additional $10,000 to give themselves a flexibility option? (Note: Do not round your intermediate calculations.)

$77,783

$75,169

$86,426

$67,652

What will be the value of St. Margaret Beer Co.s flexibility option?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Capital Market Finance

Authors: Patrice Poncet, Roland Portait, Igor Toder

1st Edition

3030845982, 978-3030845988

More Books

Students also viewed these Finance questions