Problem 12-11

Vaughn Clothing is considering refurbishing its store at a cost of $1.4 million. Management is concerned about the economy and whether a competitor, Viola Apparel, will open a store in the neighborhood. Vaughn estimates that there is a 60% chance that Viola will open a store nearby next year. The state of the economy probably won't affect Vaughn until the second year of the plan. Management thinks there is a 40% chance of a strong economy and a 60% chance of a downturn in the second year. Incremental cash flows are as follows:

Year 1: Viola opens a store - $700,000 Viola doesn't open a store - $900,000 Year 2: Viola opens a store, strong economy - $850,000 Viola opens a store, weak economy - $700,000 Viola doesn't open a store, strong economy - $1,500,000 Viola doesn't open a store, weak economy - $1,200,000

Look at the decision tree diagram ($000) and calculate the probabilities and NPVs along each of its four paths. Then calculate the overall expected NPV. Assume Vaughn's cost of capital is 17%. Enter your NPV answers in thousands of dollars and not in whole dollars. For example, an answer of $1.12 thousand should be entered as 1.12 not 1,120. Round the NPV answers to two decimal places. Use a minus sign to indicate a negative NPV. Do not round intermediate calculations. Round PVF values in intermediate calculations to four decimal places. Round your probability answers to two decimal places.

Path	NPV	Probability
1	$
2	$
3	$
4	$

Overall expected NPV = $