Use the following information to answer the following problems
The Manufacturing company, Inc. (MC) is considering performing a feasibility study for a new product available from one of its foreign suppliers. Because MC will have to make an investment of $50 million in order to obtain exclusive U.S. marketing rights to the product the firm is contemplating performing a feasibility study of the product’s market potential. The cost of the study which will take two years to complete is an upfront fee of $2 million. Included in this cost is an exclusive option that gives MC two years in which to make the decision to pay the foreign supplier the $50 million. MC’s preliminary estimates indicate that there is a:
50 percent chance of strong product demand, which will result in cash flows of $13 million per year for 8 years. The first cash inflow occurs in year 3.
20 percent chance of moderate product demand, which will result in cash inflows of $12 million per year for 8 years. The first inflow occurs in year 3
30 percent chance of weak demand, which will result in cash inflows of $7 million per year for 8 years. The first cash inflow occurs in year 3.
After MC sees the results of the feasibility study, it will decided whether to invest the $50 million or not MC’s cost of capital applicable to the proposed new product decision is 13.5 percent
1. Ignoring the cost of the study, estimate the NPV of moderate product demand in year 2.
2. Ignoring the cost of the study. Estimate the NPV of wear product demand in year 2
3. Find the Static NPV of performing the $2 million feasibility study
4. Find the dynamic NPV of performing the $2 million feasibility study
5. Find the Value of the option to abandon