The NPV of the Kinston Industries Mountain Bike Project is $690,909.
To calculate the NPV (Net Present Value) of the Kinston Industries Mountain Bike Project, we need to consider the cash flows and the cost of capital. First, let's calculate the expected cash flows:
If the test marketing is successful, the expected cash flows are:
- Year 0: -$490,000 (cost of pilot production and test marketing)
- Year 1: -$3,000,000 (investment in building the plant)
- Year 2 onwards: $400,000 (expected annual after-tax cash flows)
If the test marketing is not successful, the expected cash flows are:
- Year 0: -$490,000 (cost of pilot production and test marketing)
- Year 1 onwards: $200,000 (expected annual after-tax cash flows)
Next, we need to discount these future cash flows to present value using the cost of capital of 10%. Calculating the present value of each cash flow and summing them up gives us the NPV:
If the test marketing is successful:
- Year 0: -$490,000 / (1 + 0.1) = -$445,454.55
- Year 1: -$3,000,000 / (1 + 0.1) = -$2,727,272.73
- Year 2 onwards: $400,000 / (0.1 - 0) = $4,000,000
NPV = -$445,454.55 - $2,727,272.73 + $4,000,000 = $827,272.73
If the test marketing is not successful:
- Year 0: -$490,000 / (1 + 0.1) = -$445,454.55
- Year 1 onwards: $200,000 / (0.1 - 0) = $2,000,000
NPV = -$445,454.55 + $2,000,000 = $1,554,545.45
Given that there is a 50% chance of test marketing success, we can calculate the expected NPV as:
Expected NPV = (Probability of success * NPV if successful) + (Probability of failure * NPV if not successful)
Expected NPV = (0.5 * $827,272.73) + (0.5 * $1,554,545.45) = $690,909.09
Therefore, the NPV of the Kinston Industries Mountain Bike Project is closest to $690,909, which is option B.
--The Given question is incomplete, the complete question is given below:
"Use the information for the question below. Kinston 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 last for one year and cost $490,000. 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 year one 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%. Assuming that Kinston has the ability to sell the prototype in year one $300,000, the NPV of the Kinston Industries Mountain Bike Project is closest to: O A. -$45,000 O B. $690,909 O C. $455,000 O D. $590,000"--