Question

Please do in excel showing the work

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. Should Wansley purchase the paper company? b. 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%. c. 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%.

Answer 1

Answer -1
Cash outflow Initial		300 Mn
Cash Flow per Annum for 20 years		40 Mn
Cost of capital		0.13
Formula		=PV(rate,no. of years, amount)
Calculation		=PV(0.13,20,40)
Present value of Cash flow per annum		281
Initial cash outflow		300
Net present value		-19
Conclusion : - Project is not feasible as the NPV is negative
Answer -2 As per this question, company have the right to sell the company if they dont find it feasible i.e generating revenue of 30mn on year 1 - 30 Mn on year 2 - 30Mn + 280 Mn Total discounted value using discount rate of 13% = 269 It does not make sense to apply the decision tree here because while applying cash stream of 40 Mn , NPV was negative so if we consider 30Mn then also NPV must be negative, so dont take the project Answer 3 It makes sense to wait for the 1 year and check out the pattern of cash flow. If cash flow is 30 then abandon the project, if cash flow is 50 then go ahead So its a good approach that to wait and then decided whether purchase or not. Thanks Best regards