Question

Marcal can wait for 1 year and find out whether the cash flows will be $50 million per year or $90 million per year before deciding to purchase the company. If it waits to purchase, Marcal can no longer sell the company for $450 million 2 years after purchase. Does decision-tree analysis indicate that it makes sense to purchase the electronics company? If so, when? Again, assume that all cash flows are discounted at 15%. (NPV calculation required)

Answer 1

Calculation of NPV

If cash Flows are $50 million

($ in Million)

Year	Cash Flow	PVF @ 15%	Present Value
1		0.8696	$                 -
2	$          50	0.7561	$           37.81
3	$          50	0.6575	$           32.88
4	$        333	0.5718	$         190.58
		Net present Value	$         261.27

If cash Flows are $90 million

($ in Million)

Year	Cash Flow	PVF @ 15%	Present Value
1		0.8696	$                 -
2	$          90	0.7561	$           68.05
3	$          90	0.6575	$           59.18
4	$        600	0.5718	$         343.05
		Net present Value	$         470.28

Expected value after two years from the date of purchase = $261.27x0.5+$470.28x0.5

= $130.64+235.14

= $365.78 million

Note: Assumed Probability as 0.5 and 0.5 for cash flows.

Since the selling value of company is $450 million which is more than expected value $365.78 million it makes sense to purchase electronics company.

If we consider individually

At cash flows $50 million , it is sensible

At Cash flows $90 million, it is not sensible to purchase.