Cash flow per year from producing the high-end camera

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Reference no: EM131079549

Your company is considering whether to develop a new digital video camera. If you spend $2 million now and $2 million next year, then in 2 years from now you will have a prototype based on new technology. You will then learn whether its performance is superior to existing technology, about the same, or inferior. The probability of superior technology is 25%, the probability that performance is about the same is 45%, and the probability of inferior performance is 30%. You can then decide whether to abandon the project (in which case no further cash flows occur), or to invest $10 million in a production facility to manufacture a high-quality camera, or to invest $7 million in a production facility to manufacture a lowquality camera. If you go ahead and invest, you will then receive equal cash flows from producing the camera at the end of each of the next 4 years. If the technology is superior, the cash flow per year from producing the high-end camera would be $6 million, and for the low-end camera it would be $4 million. If the technology is about the same as existing technology, the cash flow per year from producing the high-end camera would be $4 million, and for the low-end camera it would be $3.5 million. If the technology is inferior, the cash flow per year from producing the high-end camera would be $1.5 million, and for the low-end camera it would be $2 million. The discount rate is 12%. Should you develop the new camera or not? Draw a decision tree and show your work associated with the recommendation you make.

Reference no: EM131079549

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