Hamburgers is considering introducing a new vegetarian and guacamole hamburger entrée in its food trucks. It...

Hamburgers is considering introducing a new vegetarian and guacamole hamburger entrée in its food trucks. It will cost $50,000 and take 1 year to develop and test the new recipe. If the test marketing isn't successful, then HH will abandon the idea (probability 40% ). If the test marketing is successful (probablity 60%) then 1 year from now HH will invest another $100,000 in upgrading its fleet of food trucks to sell this new hamburger. This upgrade will take a year to complete. If HH decides to sell the hamburgers then if it is well-accepted by the market, cash flows will be $20,000 per year for 5 years (probablity = 70%). These cash flows will start in Year 2. If the new hamburger is not well-accepted, the cash flows will only be $5,000 per year for 5 years, starting in Year 2. However if after the first year of poor sales HH doesn't want to continue selling the new hamburgers, it can sell the secret recipe to its competitor for $20,000 and no longer sell the hamburgers. The cash flow from this sale would occur at the end of Year 2. HH's cost of capital is 10.0%.

What is the joint probability that HH will end up receiving $20,000 per year for its hamburger sales?

What is the NPV of the branch of the decision tree in which HH starts selling hamburgers, finds out they aren't successful and then can sell the recipe if it wants to?

Solutions

Expert Solution


	Joint Probability of Receiving $20,000 per year for 5 years	0.42	(0.7*0.6)

	Cash Flow at the end of year 2	$25,000	(5000+20000)
	Probability of cash flow	0.18	(0.3*0.6)
	Expected cash flow in Year 2	$4,500	(25000*0.18)

	Present Value (PV) of Cash Flow:
	(Cash Flow)/((1+i)^N)
	i=Discount Rate=Cost of capital=10%=	0.1
	N=Year of Cash Flow

PV1	Present value of expected cash flow in year2	$3,719	(4500/(1.1^2)
	Expected cash flow in year 1	($60,000)	(-100000*0.6)
PV2	Present value of expected cash flow in year1	($54,545)	(-60000/1.1)
PV3	Present Value of initial investment	($50,000)
PV1+PV2+PV3	Net Present Value (NPV)	-$100,826

jeff jeffy answered 1 year ago

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