Students at Hayvard University are interested in developing a 6th generation 3D printer. The project has a two-year life with an initial investment of $160,000 to
fund a year-long development phase. At the end of a year, a further $85,000 is
required for production. Cash inflows from sales will occur at the end of the second
year.
The Project Manager of this additive manufacturing development team at the
university is very aware of the uncertainty about the amount of cash inflows as it is
unclear whether the market will embrace such a new innovative device. The
management team believes there is a 70 percent probability that the new device will
be a success. They also believe that the direction of device will become more
apparent over the next year. In particular, there is an 80 percent chance that the
direction over the next year will continue over the subsequent year. If the device is
initially a success and this direction continues in the next year, the payoff will be
$465,000. If the device is a success but does not continue to be a success in the
subsequent year, the payoff is $175,000. If the device is initially unsuccessful but
reverses trend in the following year, the payoff is $225,000. If the device is initially
not a success and this direction continues in the subsequent year, the payoff is -
$115,000.
Suppose also that the required return on projects of this type is 11 percent.
i.
Draw the decision tree.
ii.
Determine the expected NPV of the project. Show all appropriate
calculations