Question
Martin Manufacturing, Inc. is considering the possibility of re-opening its Independence, Missouri manufacturing facility that produces high-quality tires for commercial vehicles. The initial costs of
Martin Manufacturing, Inc. is considering the possibility of re-opening its Independence, Missouri manufacturing facility that produces high-quality tires for commercial vehicles. The initial costs of re-opening this plant that will be incurred now at t = 0 total $500,000. Martin Manufacturing estimates that it can produce 100,000 tires per year at this facility; the plant will run for a total of two years. At the conclusion of this two-year time-frame, Martin will shut the plant down at no additional cost. Two possible scenarios exist for this Independence, Missouri plant. Martin estimates that each of these scenarios has a .50 or 50% probability of occurring. Under the first scenario, the selling price per tire will be $450 in Year One; this selling price is expected to increase to $500 per tire in Year Two. Under the second scenario, the selling price per time will be $400 in Year One; this selling price is expected to decrease to $350 per tire in Year Two due to increasing competition in the market place. Throughout this two-year time period, Martin estimates that the cost of producing a tire at the Independence, Missouri plant will be $375. This cost per tire is expected to remain constant, regardless of which market scenario occurs. Martin Manufacturing has a Weighted Average Cost of Capital (WACC) of 10%.
a. Draw a decision tree diagram showing the two possible scenarios that may occur at the Independence, Missouri plant over the upcoming two years.
b. Calculate the present value (PV) of each branch of the decision tree.
c. Using the probability values for each branch ( .50 or 50%), calculate the expected present value of the cash flows generated by this project.
d. What is the Net Present Value (NPV) of this project, given that re-opening the Independence, Missouri plant will cost Martin Manufacturing $500,000 at t = 0?
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