Wansley Lumber is considering the purchase of a paper company, which would require an

initial

investment of $300 million. Wansley estimates that the paper company would

provide

net cash flows of $40 million at the end of each of the next 20 years. The cost

of

capital

for the paper company is 13%.

a.

Wansley realizes that the cash flows in Years 1 to 20 might be $30 million per

year or

$50

million per year, with a 50% probability of each outcome. Because of the nature

of

the

purchase contract, Wansley can sell the company 2 years after purchase (at Year

2

in

this case) for $280 million if it no longer wants to own it. Given this

additional information,

does

decision-tree analysis indicate that it makes sense to purchase the paper

company?

Again, assume that all cash flows are discounted at 13%.

b. Wansley can wait for 1 year and find out whether the cash flows will be $30 million

per year or $50 million per year before deciding to purchase the company. Because

of the nature of the purchase contract, if it waits to purchase, Wansley can no longer

sell the company 2 years after purchase. Given this additional information, does

decision-tree analysis indicate that it makes sense to purchase the paper company? If

so, when? Again, assume that all cash flows are discounted at 13%.