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a. You just finished a week of heli-skiing and had such a good time that you...

a. You just finished a week of heli-skiing and had such a good time that you want to go again next year. Plus, the heli-ski outfit is offering the following deal: If you pay for your vacation now, you can get a week of heli-skiing for $2,500. However, if you cannot ski because the helicopters cannot fly due to bad weather, there is no snow or you get sick, you do not get a refund. There is a 20% probability that you will not be able to ski. Your other option is to wait and book the trip one week before you go. The heli-ski company requires a minimum of one week advanced booking. In this case, your cost is $5,000, but you can be much more certain about the conditions, your health and the weather. Now, the probability that you will not be able to ski is only 5%. In either case, you estimate the pleasure you get from heli-skiing is worth $6,000. If your cost of capital is 8% per year, should you book ahead or wait?

b. Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing. Kinston can immediately pay $500,000 for pilot production and test marketing. Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike. If the test-marketing phase is successful, then Kinston Industries will invest $3 million in one year to build a plant that will generate expected annual after tax cash flows of $400,000 in perpetuity beginning in year two. If the test marketing is not successful, Kinston can still go ahead and build the new plant, but the expected annual after tax cash flows would be only $200,000 in perpetuity beginning in year two. Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000. Kinston's cost of capital is 10%. What is the NPV?

c. Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing. Kinston can immediately pay $500,000 for pilot production and test marketing. Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike. If the test-marketing phase is successful, then Kinston Industries will invest $3 million in one year to build a plant that will generate expected annual after tax cash flows of $400,000 in perpetuity beginning in year two. If the test marketing is not successful, Kinston can still go ahead and build the new plant, but the expected annual after tax cash flows would be only $200,000 in perpetuity beginning in year two. Kinston has the option to not build the plant. Kinston's cost of capital is 10%. What is the NPV?

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jeff jeffy answered 1 year ago
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