The company Surf Stavanger is starting a new business in Stavanger, selling lessons for stand up paddling at Stokkavannet. So far, the company has invested 1 million NOK in market research and marketing, and needs to invest a further 3.0 million in equipment to become operational. Their market report indicate that people are willing to pay 1 200 NOK an hour for paddling lessons. They estimate that they can sell a 3 hour course 3 times a week with an average of 10 participants at each course. With operations in 40 weeks a year the total number of hours sold is 3 600 a year. The project is considered for a 5 year period, starting from next year, and you can assume a straight line depreciation with zero salvage value. The cash flow will be the same for each year, i.e. no growth in the operational cash flow.

Below is a summary of the variables:

a) Set up the project's cash flow and calculate the Net Present Value (NPV) by assuming a discount rate at 10%. Should Surf Stavanger make the investment? b) The annual production of 3 600 hours a year is an optimistic estimate, and Surf Stavanger wants to estimate a pessimistic scenario. In this scenario, they estimate a sales price of 800 NOK/hour and selling only 2 800 hours a year. Calculate the expected NPV if there is a 50% chance for both the optimistic and the pessimistic scenario.

Surf Stavanger is considering using a new environmental friendly technology for the paddle board which will reduce the variable cost with 50%. With this board, Surf hope to increase their chances of the optimistic scenario to 75%, leaving a 25% chance for the pessimistic scenario. The technology comes at a price, and Surf needs to invest an additional 1 million to make the board functional.

c) Use a decision tree and make necessary calculations to estimate what alternative is most profitable (existing paddle board or new technology). d) Are there other considerations that may affect the decision in (c)?

Variable Market Research Investment in Equipment Sales Price Variable cost Fixed costs Annual Production Project Life Salvage Value Discount Rate Tax rate OCF growth rate Value 1000000 3 000 000 1 200 250 1 200 000 3 600 5 0 10 25 0 Unit NOK NOK NOK/hour NOK/hour NOK/year Hours Years NOK % % % Variable Market Research Investment in Equipment Sales Price Variable cost Fixed costs Annual Production Project Life Salvage Value Discount Rate Tax rate OCF growth rate Value 1000000 3 000 000 1 200 250 1 200 000 3 600 5 0 10 25 0 Unit NOK NOK NOK/hour NOK/hour NOK/year Hours Years NOK % % %