Decision Tree Problem

Suppose that Blazer Coal Mining Company is considering the reopening a coal mine in Walker County. The net investment for this project can be broken down into stages as set below.

Stage 1: at time Period Zero, which is today, the firm can begin to make an environmental and geological study for the amount of coal that can be extracted with current technologies and under current environmental regulations. This survey or study will cost $500,000.There is an 80% probability that the survey will show that the firm should enter this line of business and

Stage2: this study will take an entire time period, meaning that this puts us time Period 1. If the market study indicates that is feasible to enter this market, the firm will spend $1 million to design and build the infrastructure for mining. There is a 60% probability that the design will be successful in that the project should move forward. There is a 40% probability that the design will not be successful in the project will stop there.

Stage 3: if the reaction to the proposed is good, then at time Period 2 the firm will invest $10 million in the infrastructure to mine the field.

Stage 4: at time Period 3, market acceptance will be known. If demand for coal is low the firm will exercise its option to terminate or abandon the project and avoid future negative cash flows. If this stage is reached, the project will either generate high, medium or low cash flows over the next 3 years.

If the project generates high returns, that return will be $18,000,000 per year for the next three years. The probability of high returns is 30%.

If the project generates medium returns that return will be $8 million per year for the next three years. This has a 40% probability of happening.

If the project generates low returns, the firm will incur a $2 million loss on the sale of the plant they just built and the firm will exit the market. There is a 30% probability that returns will be low.

Please construct a decision tree for this firm and calculate the expected value of the project if the cost of capital to the project is 11.5%.

Scenario Problem

Blazer Coal Mining Company is considering purchasing a new dragline that will scope more coal than their existing dragline.If the economy is normal the new dragline has an expected NPV of $3,790. If natural gas prices fall causing more users to switch from coal to natural gas, the expected NPV is $-6,487. On the other hand, if natural gas prices go up, the expected NPV is 17,494. There is a 50% probability that natural gas will remain the same and therefore the demand for coal will be normal. There is an equal chance that natural gas prices will increase as that they will decline.

What is the Expected NPV of the larger dragline? What is its standard deviation and its coefficient of variation (CV)? Show your computations in XLS.