Reference no: EM132804670
AMC Corporation is considering investment in technology to enhance the operational efficiency in its plants. The investment will be done in stages and assessed along each phase of development. Each phase in done in the subsequent year. The Research and Development costs will total $450,000. The development may be done in-house or outsourced to a third party firm. Those research are near its completion. If the research shows positive results (70% probability) the firm will do the development in-house. Otherwise the development will be move to an outsourced firm for further testing and development.
In-house development would be done in the first phase (year 1) and will cost $750,000. There is an 80% probability that the development goes well. If it does not go well, the development will cease and the project will be salvaged for $350,000. It the development goes well then large-scale production will be done in the next phase (phase 2), costing $500,000. Sales will begin in the year following (phase 3) and will depend on the state of the economy, which may be strong (60%), fair (30%) or weak (10%). If the economy is strong, sales will be $4 million each year for 2 years. If the economy is fair, sales will be $2.5 million each year for 2 years. If the economy is weak, sales will be $1 million each year for 2 years.
Outsourcing the project development will cost $500,000. This will be in phase 1 of the project. If progress is made (60% probability) then the project would move on to production costing $800,000. If not progress is made, then the project will be abandoned without salvage. If the project moves forward sales would be the same as for the in-house development.
Required:
1. Construct the decision tree to show the decision being considered for AMC Corporation.
2. Calculate the expected sales from the project if the project is done in-house.
3. Calculate the expected sales from the project if the project is done by outsourcing.
4. Calculate the expected Net Present Value of the project.
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