Consider the case: Industrialization Enterprise is considering a three year proj
ID: 2742951 • Letter: C
Question
Consider the case: Industrialization Enterprise is considering a three year project that will require an initial investment of $43,500. If market demand is strong, Industrialization Enterprise thinks that the project will generate cash flows of $28,000 per year. However, if market demand is weak, the company believes that the project will generate cash flows of only $2,000 per year. The company thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak. If the company uses a project cost of capital of 11%, what will be the expected net present values of this project? a. -7,530 b. -5,476 c. -6,845 d. -6,161 Industrialization Enterprise has the option to delay starting this project for one year so that analysts can gather more information about whether demand will be strong or weak. IF the company chooses to delay the project, it will have to give up a year of cash flows, because the project will then be only a two year project. However, the company will know for certain if the market demand will be strong or weak before deciding to invest in it. What will be the expected NPV if Industrialization Enterprise delays starting the project? a. 1,704 b. 4,010, c. 2,005 d. 8,850 What is the vale of Industrialization Enterprise's option to delay the start of the project? a. 1,704 b. 2,005 c. 8,850 d. 4,010 e. 24,924
Explanation / Answer
A- NPV -$6845
Average Cash flow annual= $15000
Calculation of NPV
B- after one year Market may be strong or weak but in question is not mentioned what is market condition after delaying project.we have to calculate best case and worst case NPV.
Best case Cash flow= $28000
Worst Case Cashflow= $2000
But if market is worst case then company will not to accept project hence second NPV is not relevant.
Market Condition Probablity Cash flow Prob.x CF Strong 0.5 $28,000.00 $14,000.00 Weak 0.5 $2,000.00 $1,000.00 Total $15,000.00