Reference no: EM132937746

Question - Welsh Chwarae plc., a manufacturer of computer peripherals, is introducing a new type of lightspeed wireless gaming headset this year. The company is considering whether to put the new product into production. Details of the project are below.

i. If the new headset is a success, the firm expects to be able to sell 60,000 units a year at a price of £65 each. If the new headset is not well received, only 30,000 units can be sold at a price of £45. The company estimated that each outcome is equally likely.

ii. The variable cost of each headset is £20 and the fixed costs are zero. The cost of manufacturing equipment to be paid upfront is £8 million, and the project life is estimated to last 10 years. The manufacturing equipment will be depreciated straight-line to zero over 10 years.

iii. Welsh Chwarae's tax rate is 25% and it requires a return of 18% on all new projects.

1) Using a decision tree, display the company's decision that incorporates the option to abandon described above. Make sure to clearly represent and explain all the relevant points on the decision tree and the net present values associated with each decision. Show any additional computations for the NPV at each decision node, if necessary. Note that the decision to abandon can be made regardless of the demand for the new headset.

2) Using no more than 100 of your own words, explain why options to expand or contract production are most valuable when forecasts about future business conditions are more uncertain.