Stay Swift Corp. is looking at investing in a production facility that will requ
ID: 2766794 • Letter: S
Question
Stay Swift Corp. is looking at investing in a production facility that will require an initial investment of $500,000. The facility will have a three-year useful life, and it will not have any salvage value at the end of the project’s life. If demand is strong, the facility will be able to generate annual cash flows of $260,000, but if demand turns out to be weak, the facility will generate annual cash flows of only $130,000. Stay Swift Corp. 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 12%, what will be the expected net present value (NPV) of this project?
-$20,568
-$31,643
-$22,150
-$26,897
Stay Swift Corp. could spend $510,000 to build the facility. Spending the additional $10,000 on the facility will allow the company to switch the products they produce in the facility after the first year of operations if demand turns out to be weak in year 1. If the company switches product lines because of low demand, it will be able to generate cash flows of $255,000 in years 2 and 3 of the project.
What is the expected NPV of this project if Stay Swift Corp. decides to invest the additional $10,000 to give themselves a flexibility option?
$33,724
$75,880
$47,401
$52,668
What will be the value of Stay Swift Corp.’s flexibility option? selector 1
$33,724
$52,668
$75,880
$47,401
Explanation / Answer
cash inflow 260000 0.5 130000 130000 0.5 65000 total cash flow 195000 year cash flow present value @12% present value of cash flow 1 195000 0.89285714 174107.1 2 195000 0.79719388 155452.8 3 195000 0.71178025 138797.1 sum of present value of cash flow 468357.1 cash outflow 500000 NPV -31642.9 year cash flow present value @12% present value of cash flow 1 195000 0.89285714 174107.1 2 255000 0.79719388 203284.4 3 255000 0.71178025 181504 sum of present value of cash flow 558895.5 cash outflow 510000 NPV 48895.54