In this section students should demonstrate understanding, knowledge, and an ability to critically evaluate the differing theoretical viewpoints associated with the topic. The response should attempt to incorporate a critical perspective through relevant academic referencing, rather than overly describing the topic. Attempting to evaluate within a practical, real-life business context through investigation of academic empirical findings will assist in developing the response.

Task 3

Designs for RR Ltds fashion lines are created inhouse and manufacturing takes place across numerous locations in Birmingham, however the company is keen to expand into Asian-Pacific markets and is considering a small manufacturing base in Vietnam.

The project will have an initial outlay of 1m and a 0.2 probability of producing a return of 700,000 in Year 1 and a 0.8 probability of delivering a return of 600,000 in Year 1. If the 700,000 result occurs, then the second year could return either 600,000 (probability of 0.5) or 300,000 (probability of 0.5). If the 600,000 result for Year 1 occurs, then either 700,000 (probability 0.8) or 400,000 (probability 0.2) could be received in the second year. All cash flows occur on anniversary dates. The discount rate is 14%

Required:

1) Calculate:

a) The expected NPV.

b) The standard deviation of NPV.

c) The probability of the NPV being less than zero assuming a normal distribution of return

(bell shaped and symmetrical about the mean).

2) Based on your analysis of the macroeconomic risk factors, you believe that if the project was delayed by a year, RR Ltd would be able to improve the accuracy of the Year 1 probability estimates, which could lead to a reduced initial outlay and discount rate.

Upon finishing your calculations, a colleague states that the traditional NPV method is just as effective as an NPV method incorporating probabilities and real option perspectives. Critically evaluate this statement.