After finding the NPV on Nick's proposal, Nora countered that her suggestions for marketing the product actually had higher value despite not having more widespread distribution.She estimates that to follow her proposed project outline, it would require less up-front capital to get started due to reduced manufacturing quantities. Despite selling at a higher price, the reduced quantity sold would result in lower cash flows annually.Using the numbers for his project (calculated last week), Nick shows that this would result in a higher NPV for his approach.

However, Nora feels that Nick is ignoring the option value of her alternative relative to his approach.In her business model, they would invest in manufacturing the product on a small scale initially, and market at higher prices in smaller retail outlets.If successful, they would approach a large food manufacturer with their product and arrange a licensing agreement to expand production and distribution. This minimizes their initial risk, which has some inherent value to the project.If the product doesn't meet initial acceptance, they can sell off the equipment while it is relatively new and get a higher abandonment value.

Using the following information, does Nora have a point?

Initial cost in Nora's plan:$500,000

Potential cash flows in year one:$150,000 in a good year (60% chance), and only $30,000 in a bad year.

Potential cash flows in year two:If the first year was good, then you could get $250,000 in a good year (70% chance), and only $175,000 in a bad year.If the first year was bad, then there would be a 20% chance of earning $30,000 again, but you could also lose $10,000.

Options:

If you have a successful first year, you would begin the process of finding a larger food manufacturer to produce and distribute your product.You expect that marketing, legal and travel costs during this process would be $200,000. However, a deal would have a present value worth $4,000,000 to the firm in future licensing fees that would begin at the end of year two if it has a second good year, but would only be worth $2,800,000 to the firm if they have a bad second year.

If the project has a rough first year, Rosa's could sell the equipment for $20,000 to recover some of their investment.

In case you have forgotten, the WACC for the project is 6%, and the NPV of Nick's project is what we found in project 2.

Questions to answer:

4:What aspects of Nora's plan would make this more attractive to the firm which are not currently being captured quantitatively in our model?