The Alset car company, a prominent car manufacturer in France, may design a new electric based on...

Question:

The Alset car company, a prominent car manufacturer in France, may design a new electric based on the "Back to the Future" movies.

First, Alset would have to invest $10,000 in t = 0 for the design and testing of the new car. Alset's managers believe there is a 70% probability that the phase will be successful and the project will continue. If Stage 1 is not successful, the project will be abandoned at zero salvage value. The next stage, if undertaken, would consist of making the mock-ups and prototypes of three cars. This would cost $750,000 at t = 1. If the cars test well, Alset would go into production. If they do not, the mockups and prototypes could be sold for $500,000 in t =2. The managers estimate the probability is 80% that the cars will pass testing and that Stage 3 will be undertaken. Stage 3 consists of converting an unused production line to produce the new design. This would cost $2M at t = 2.

If the economy is strong at this point, the net value of sales would be $5.0M; if the economy is weak, the net value would be $1.8M. Both net values occur at t = 3, and each state of the economy has a probability of 0.5. Alset's corporate cost of capital is 14%.

Construct a decision tree and determine the projects expected NPV.

Decision Tree Analysis

Decision Tree analysis is a common way to represent the alternatives to be taken which uses a tree-like graph or model of decisions and their possible consequences, including chance of event outcomes, costs, and results. It also helps to form a detailed picture of the risks and rewards associated with each possible course of action.

To evaluate a project with decision tree, all NPV-s are calculated with possible probabilities and then the net value is calculated.

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Construct a decision tree and determine the projects expected NPV.

We make a decision tree depending upon the details: (I = Investment, V = Value, P...

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Analyzing Business Problems Using Decision Trees & Payoff Tables

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Chapter 5 / Lesson 5
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Businesses are faced with decisions every day, but how do you figure out the best course of action for your business? In this lesson, we'll explore two tools to help you out: decision trees and payoff tables.


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