Question

In: Finance

Describe the benefits and costs of delaying an investment opportunity. Your engineers are developing a new...

Describe the benefits and costs of delaying an investment opportunity.

Your engineers are developing a new product to launch next year that will require both software and hardware innovations. The software team requests a budget of $5 million and forecasts an 80% chance of success. The hardware team requests a $10 million budget and forecasts a 50% chance of success. Both teams will need 6 months to work on the product, and the risk-free interest rate is 4% APR with semiannual compounding.

a. Which team should work on the project first?

b. Suppose that before anyone has worked on the project, the hardware team comes back and revises their proposal, changing the estimated chance of success to 75% based on new information. Will this affect your decision in (a)?

Solutions

Expert Solution

Answer to a)

Given 4 % APR (Which is annual Percentage Rate) with semi annual compounding.

Therefore 6 months Interest Rate - 4%/2 = 2%

Now, Analysis of Development by Software Team

Initial Outflow - $5 million

Expected Inflow - 80% Chance of Success

Which implies - 80%* $5 million

= $ 4 Million

Present Value of Future Cash inflow = $ 4 Million / 1.02 = $ 3.92 Million

Now NPV = - $ 1.08 Million (Outflow -Inflow)

Now, Analysis of Development by Hardware Team

Initial Outflow - $10 million

Expected Inflow - 50% Chance of Success

Which implies - 50%* $10 million

= $ 5 Million

Present Value of Future Cash inflow = $ 5 Million / 1.02 = $ 4.90 Million

Now NPV = - $ 5.1 Million (Outflow -Inflow)

Therefore we see that the chances of loss (in monetary Terms as computed above) in the development by the software team is less as compared to the hardware team. Therefore software team should work first on the project.

Answer to b)

Now the revised Expected Cash inflow of Hardware team - 75% of Success

=75% of $ 10 Million

$ 7.5 Million

Now Present Value of the inflow = $ 7.5 Million/ 1.02 = $ 7.35 Million

NPV = - $ 2.64 Million

On the basis of new information we see that chance of loss of the development by the hardware team is less as compared to the software team on the basis of new information.

Therefore Harware team to be first allowed to do the development.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

You are considering an investment opportunity with the following costs and benefits. The applicable interest rate...

You are considering an investment opportunity with the following costs and benefits. The applicable interest rate for this investment opportunity is 5% (effective annual rate). Calculate the NPV of this investment opportunity. Year 0 1 2 3 4 5 6 Cost $ (10,000) $ (5,000) $ (1,000) $ - $ - $ - $ - Benefits $ - $ - $ 5,000 $ 7,500 $7,500 $ 5,000 $ 1,000

Describe some of the benefits and costs associated with the emergence of large cities in developing...

Describe some of the benefits and costs associated with the emergence of large cities in developing countries.

Kagle design engineers are in the process of developing a new “green” product, one that will...

Kagle design engineers are in the process of developing a new “green” product, one that will significantly reduce impact on the environment and yet still provide the desired customer functionality. Currently, two designs are being considered. The manager of Kagle has told the engineers that the cost for the new product cannot exceed $550 per unit (target cost). In the past, the Cost Accounting Department has given estimated costs using a unit-based system. At the request of the Engineering Department,...

Describe both the costs and benefits of Foreign Direct Investment (FDI) to the home and host...

Describe both the costs and benefits of Foreign Direct Investment (FDI) to the home and host countries. (400 words – Maximum in your own words) Please no Plagiarism

Describe both the costs and benefits of Foreign Direct Investment (FDI) to the home and host...

Describe both the costs and benefits of Foreign Direct Investment (FDI) to the home and host countries.

What are the benefits and opportunity costs to a bank that maintains a consistent level of...

What are the benefits and opportunity costs to a bank that maintains a consistent level of excess reserves?

describe differential cost, avoidable costs, sunk costs, and opportunity costs

(A) Describe the costs and benefits of the “stay” foraging strategy. (B) Describe the costs and...

(A) Describe the costs and benefits of the “stay” foraging strategy. (B) Describe the costs and benefits of the “move” foraging strategy. (C) Which strategy conformed to the Marginal Value Theorem?

You have the opportunity to make an investment that costs $900,000. If you make this investment...

You have the opportunity to make an investment that costs $900,000. If you make this investment now, you will receive $100,000 one year from today, $250,000 and $800,000 two and three years from today, respectively. The appropriate discount rate is 12%. Should you make the investment?

Return on Assets is a good way to measure the opportunity costs of an investment. If...

Return on Assets is a good way to measure the opportunity costs of an investment. If a company has a Return on Assets of 12% and a line of Credit at 6%, how should they manage their cash flow? What is the correct answer? Explanation needed a) they should use the line of credit to finance expansion and use the cash to cover project level cash flow. b) They should use the line of credit for project cash flow, and...

Subjects