In: Finance
QUESTION 8
VFIC Industries has come up with a new mountain bike prototype
and is ready to go ahead with pilot production and test marketing.
The pilot production and test marketing phase will cost $100,000
and last for one year. The management team believes that there is a
30% 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 VFIC will invest $2
million to build a plant immediately that will generate expected
annual after-tax cash flows of $300,000 in perpetuity starting in
year two. If the test marketing is not successful, VFIC can still
go ahead and build the new plant, but the expected annual after-tax
cash flows would be only $150,000 in perpetuity starting in year
two. VFIC's cost of capital is 10%.
Suppose that VFIC has the option to sell the prototype mountain
bike at the end of the first year for $50,000. The NPV of the VFIC
Mountain Bike Project is around: