Question
You are trying to decide whether to make an investment of $500.1 million in a new technology to produce Everlasting Gobstoppers. There is a 61%
You are trying to decide whether to make an investment of $500.1 million in a new technology to produce Everlasting Gobstoppers. There is a 61% chance that the market for these candies will produce profits of $99.6 million annually, a(n) 20% chance the market will produce profits of $50.3 million, and a(n) 19% chance that there will be no profits. The size of the market will become clear one year from now. Currently, the cost of capital of the project is 10.67% per year. There is a(n) 19% chance that the cost of capital will drop to 9.08% in a year and stay at that level forever, and a(n) 81% chance that it will stay at 10.67% forever. Movements in the cost of capital are unrelated to the size of the candy market. Construct the decision tree that shows the choices you have: to make the investment either today or one year from now.
What decision should you make if the one-year cost of capital is15.81% and the profits last forever? And what is the NPV of the decision?
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