A company has evaluated two product development projects and determined their expected lifetime income given a set of events.
Project A has an initial cash outlay of $150,000 and Project B has an initial cash outlay of $200,000. The projects are mutually exclusive.
Event Outcomes Project A Project B
Result Likelihood Income, adjusted for time Income, adjusted for time
Down market and poor launch 30% $50,000 $0
Up market and poor launch 25% $250,000 $100,000
Down market and successful launch 25% $100,000 $500,000
Up market and successful launch 20% $350,000 $600,000
A What are the expected cash flows from Project A and Project B?
B Which project would you recommend? Why?
A third project can be undertaken along with A or C.
Event Outcomes Project C Income, adjusted for time
Down market and poor launch $60,000
Up market and poor launch $300,000
Down market and successful launch $80,000
Up market and successful launch $320,000
C What are the expected cash flows from Project C?
D If the company is risk averse, would you recommend a combination of Project A and C, or Project B and C? Why?