QUESTION THREE

Sidney, the head of new product development, has decision rights over what new product to develop. Once Sidney has decided which product to develop, her effort level will impact the success of the product.

She can choose either New Product A or New Product Project B. The cash flows and present value of the cash flows with low and high effort on Sidney's part are shown below for both projects. High effort improves the cash flows by 10% versus low effort. The present value of the cash flows is calculated with a 7% discount rate which is assumed to be the shareholder's discount rate.

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