We see from Panel B of Exhibit 12.7 that XYZ should invest in the project only if the revealed level of consumer demand was high or medium. Show calculations as to why no investment should be made if the revealed level of demand (in period 1) was low.

EXHIBIT 12.7 Decision Trees: Real Options Analysis (Investment-Timing Option) K $50 A B D E F G H 1 1 Panel A: Expected NPV--Invest in Project Today (time 0); amounts in $ millions 2 3 Discount rate (WACC) = 15.00% 4 5 Cash Outflow Market Demand End-of-Period Cash Inflows NPV of Weighted 6 @ time 0 (Scenario) Probability 1 2 3 Scenario NPV 7 High 0.25 $70 $70 $70 $59.826 $14.956 8 $100 Medium 0.50 $50 $50 $14.161 $7.081 9 Low 0.25 $5 $5 $5 ($88.584) ($22.146) 10 1.00 Expected NPV = ($0.109) 11 12 Panel B: Expected NPV--Delay Investment by One Year, Only if NPV is increased; amounts in $ millions 13 14 Discount rate (WACC) = 15.00% 15 Risk-free rate- 5.00% 16 Cash outflow in one year = $100 17 18 Market Demand End-of-Period Cash Inflows PV of Cash PV of Cash Weighted 19 (Scenario) Probability 1 2 3 4 Outflows Inflows NPV @ time of 20 High 0.25 ($100) $70 $70 $70 ($95.238) $138.979 $10.935 21 Medium 0.50 ($100) $50 $50 $50 ($95.238) $99.271 $2.016 22 Low 0.25 $0 $0 $O $0 $0.000 $0.000 $0.000 23 1.00 Expected NPV = $12.951 24 * discounted at risk-free rate of interest 25 + discounted at WACC (weighted average cost of capital); formula for cell 120: =PV(B14,1,(PV(B14,3,E20))) 26 # formula for cell J20: =(120+H20)*C20 27 28 EXHIBIT 12.7 Decision Trees: Real Options Analysis (Investment-Timing Option) K $50 A B D E F G H 1 1 Panel A: Expected NPV--Invest in Project Today (time 0); amounts in $ millions 2 3 Discount rate (WACC) = 15.00% 4 5 Cash Outflow Market Demand End-of-Period Cash Inflows NPV of Weighted 6 @ time 0 (Scenario) Probability 1 2 3 Scenario NPV 7 High 0.25 $70 $70 $70 $59.826 $14.956 8 $100 Medium 0.50 $50 $50 $14.161 $7.081 9 Low 0.25 $5 $5 $5 ($88.584) ($22.146) 10 1.00 Expected NPV = ($0.109) 11 12 Panel B: Expected NPV--Delay Investment by One Year, Only if NPV is increased; amounts in $ millions 13 14 Discount rate (WACC) = 15.00% 15 Risk-free rate- 5.00% 16 Cash outflow in one year = $100 17 18 Market Demand End-of-Period Cash Inflows PV of Cash PV of Cash Weighted 19 (Scenario) Probability 1 2 3 4 Outflows Inflows NPV @ time of 20 High 0.25 ($100) $70 $70 $70 ($95.238) $138.979 $10.935 21 Medium 0.50 ($100) $50 $50 $50 ($95.238) $99.271 $2.016 22 Low 0.25 $0 $0 $O $0 $0.000 $0.000 $0.000 23 1.00 Expected NPV = $12.951 24 * discounted at risk-free rate of interest 25 + discounted at WACC (weighted average cost of capital); formula for cell 120: =PV(B14,1,(PV(B14,3,E20))) 26 # formula for cell J20: =(120+H20)*C20 27 28