Question

AppleB is considering a classroom note taking project with an up-front cost $2,500. The project's subsequent cash flows are critically dependent on whether a competitor's similar product is accepted by the University President. If the President rejects the competitive product, AppleB's product will have high sales and cash flows, but if the competitive product is approved, that will negatively impact AppleB. There is a 65% chance that the competitive product will be rejected, in which case AppleB's expected cash flows will be $1,200 at the end of each of the next seven years (t = 1 to 7). There is a 35% chance that the competitor's product will be approved, in which case the expected cash flows will be only $525 at the end of each of the next seven years (t = 1 to 7). AppleB will know for sure one year from today whether the competitor's product has been approved. AppleB is considering whether to make the investment today or to wait a year to find out about the President's decision. If it waits a year, the project's up-front cost (in this case at t = 1) will remain the same. The subsequent cash flows will remain at $1,200 per year if the competitor's product is rejected and $525 per year if the alternative product is approved. However, if AppleB decides to wait, the subsequent cash flows will be received only for six years (t = 2 ... 7). Assuming that all cash flows are discounted at 9.5%, if AppleB chooses to wait a year before proceeding, how much will this increase or decrease the project's expected NPV in today's dollars, relative to the NPV if it proceeds today? What should AppleB do?

Answer 1

calculation of Expected NPV

the equation for finding out Expected NPV = p * Scenario NPV where, p = Probability

situation 1. when the investment project of AppleB gets acceptance.

here in this situation, it is said that the cost will be the same for year 1 as the company will wait for the decision of the University President. Therefore after calculations the Expected NPV = 39.6

situation 2 project of AppleB gets rejected.

Expected NPV = 34.52

here the company doesn't wait for the approval of the University President therefore cashflow is there right from the first year of the investment project.

On comparing with both Expected NPV the 1st situation come in handy. Because it provides higher ENPV than situation two.