Question

An auto plant that costs $100 million to build can produce a line of flexfuel cars that will produce cash flows with a present value of $140 million if the line is successful but only $50 million if it is unsuccessful. You believe that the probability of success is only about 50%. You will learn whether the line is successful immediately after building the plant.

a-1. Calculate the expected NPV. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answer in millions.)
a-2. Would you build the plant?
a. Yes
b. No
Suppose that the plant can be sold for $95 million to another automaker if the auto line is not successful.
b-1. Calculate the expected NPV. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answer in millions rounded to 1 decimal place.)
b-2. Would you build the plant?
a. Yes
b. No

Answer 1

a-1. The expected NPV is -$5 million. a-2. No, it would not be advisable to build the plant. b-1. The expected NPV is -$5 million. b-2. No, it would not be advisable to build the plant.

Step-by-step explanation:

a-1. To calculate the expected NPV, we need to multiply the probability of success (50%) by the present value of the successful outcome ($140 million) and the probability of failure (50%) by the present value of the unsuccessful outcome ($50 million). Then, subtract the cost of building the plant ($100 million) from the expected cash flows:

Expected NPV = (0.5 x $140 million) + (0.5 x $50 million) - $100 million

Expected NPV = $70 million + $25 million - $100 million

Expected NPV = -$5 million

a-2. Since the expected NPV is negative, it would not be advisable to build the plant.

b-1. To calculate the expected NPV, we need to multiply the probability of success (50%) by the present value of the successful outcome ($140 million) and the probability of failure (50%) by the present value of the unsuccessful outcome ($50 million). Then, subtract the cost of building the plant ($100 million) from the expected cash flows:

Expected NPV = (0.5 x $140 million) + (0.5 x $50 million) - $100 million

Expected NPV = $70 million + $25 million - $100 million

Expected NPV = -$5 million

Since the expected NPV is negative, it would not be advisable to build the plant.