## (solution) Kinston Industries has come up with a new mountain bike prototype

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 \$500,000. 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%.

24) Assuming that Kinston has the ability to sell the prototype in year one for \$300,000, the NPV of the Kinston Industries Mountain Bike Project is closest to:

A) -\$45,000

B) \$90,000

C) \$455,000

D) \$590,000

25) Assuming that Kinston does not have the ability to sell the prototype in year one for \$300,000 but can abandon the project (where it will get nothing in return), the NPV of the Kinston Industries Mountain Bike Project is closest to:

A) -\$45,000

B) \$90,000

C) \$455,000

D) \$590,000

26) Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately. Assuming that the probability of high or low demand is still 50%, the NPV of the Kinston Industries Mountain Bike Project is closest to:

A) \$0

B) \$90,000

C) -\$45,000

D) \$1,000,000

Use the following information for question 24 to 26.

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 \$500,000. 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%.

24) Assuming that Kinston has the ability to sell the prototype in year one for \$300,000, the NPV of

the Kinston Industries Mountain Bike Project is closest to:

A) -\$45,000

B) \$90,000

C) \$455,000

D) \$590,000

25) Assuming that Kinston does not have the ability to sell the prototype in year one for \$300,000

but can abandon the project (where it will get nothing in return), the NPV of the Kinston Industries

Mountain Bike Project is closest to:

A) -\$45,000

B) \$90,000

C) \$455,000

D) \$590,000

26) Assume that Kinston has the ability to ignore the pilot production and test marketing and to go

ahead and build their manufacturing plant immediately. Assuming that the probability of high or low

demand is still 50%, the NPV of the Kinston Industries Mountain Bike Project is closest to:

A) \$0

B) \$90,000

C) -\$45,000

D) \$1,000,000

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Sep 13, 2020

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