Kinston Industries has come up with a new mountain bike prototype and is ready to go...

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Finance

Kinston Industries has come up with a new mountain bikeprototype and is ready to go ahead with pilot production and testmarketing. The pilot production and test marketing phase will lastfor one year and cost $500,000. Your management team believes thatthere is a 60% chance that the test marketing will be successfuland that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful, then Kinston Industrieswill invest $3 million in year one to build a plant that willgenerate expected annual after tax cash flows of $395,040 inperpetuity beginning in year two. If the test marketing is notsuccessful, Kinston can still go ahead and build the new plant, butthe expected annual after tax cash flows would be only $200,000 inperpetuity beginning in year two. Kinston has the option to stopthe project at any time and sell the prototype mountain bike to anoverseas competitor for $300,000. Kinston's cost of capital is 10%.Assuming that Kinston has the ability to sell the prototype in yearone for $300,000, the NPV of the Kinston Industries Mountain BikeProject is closest to:
127,490.91
90,000.00
90,909.23
690,240.34

Answer & Explanation Solved by verified expert

3.8 Ratings (469 Votes)

Step 1 Calculate NPV if Test is Successful and Plant is Built The NPV if test is successful is calculated as below NPV Value of Investment AnnualAfter Tax Cash Flow if Test is SuccessfulCost of Capital Here Value of Investment 3000000 and AnnualAfter Tax Cash Flow if Test is See Answer

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