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You are considering producing a new product, which if it is successful will produce cash flows of $41,000 per year in perpetuity
You are considering producing a new product, which if it is successful will produce cash flows of $41,000 per year in perpetuity. If it is unsuccessful, the cash flow will be -$22,000 in the first year and then you will shut down. If the probability of success is 0.6 and the opportunity cost of capital is 4 percent, what is the maximum that you would be willing to pay to undertake the investment?
Expert Solution
Present value of success = 41,000/0.04 = 1,025,000
Expected value of success = 1,025,000 * 60% = 615,000
Present value of loss = 22,000* 40% /1.04 = 8,461.54
Maximum investment = 615,000 – 8,461.54
= 606,538.46
Answer is:
606,538.46
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