Question
The B&B mineral Water Company is proposing to market a high fiber mineral water beverage. The product will be first test marketed for 3-years in
The B&B mineral Water Company is proposing to market a high fiber mineral water beverage. The product will be first test marketed for 3-years in various retirement communities in Florida at an initial (time zero) cost of $500,000. This test period is not expected to produce any profits, but will reveal consumer preferences. There is a 40% chance that demand will be good, a 30% chance that demand will be satisfactory, and a 30% chance that demand will be bad. If demand is good, B&B will spend $5 million to launch the product in certain regional markets and will receive expected annual profit (FCFF) of $700,000 in perpetuity. If demand is satisfactory, B&B will spend $2.5 million to launch the product in certain regional markets and will receive expected annual profit (FCFF) of $300,000 in perpetuity. In both good and satisfactory cases, the investment expenditure will be made at the end of year 3, and the first cash flow will be received at the end of year 4. If demand is bad, B&B will withdraw the product.Once consumer preferences are known (i.e., at the end of 3-years), the product will be subject to an average degree of risk, and therefore, B&B will require a return of 10% on their investment. However, the 3-year test-market phase is viewed by B&B as being riskier, and therefore, they will require a 30% return on their initial test market expenditure.What is the NPV of the high fiber mineral water project?
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