The president of ChemTech is trying to decidewhether to

Chapter 18, Problem 18.37

(choose chapter or problem)

The president of ChemTech is trying to decidewhether to start a new product line or purchase asmall company. It is not financially possible to doboth. To make the product for a 3-year periodwill require an initial investment of $250,000.The expected annual cash flows with probabilitiesin parentheses are $75,000 (0.5), $90,000(0.4), and $150,000 (0.1). To purchase the smallcompany will cost $450,000 now. Market surveysindicate a 55% chance of increased sales for thecompany and a 45% chance of severe decreaseswith an annual cash flow of $25,000. If decreasesare experienced in the first year, the companywill be sold immediately (during year 1) at aprice of $200,000. Increased sales could be$100,000 the first 2 years. If this occurs, a decisionto expand after 2 years at an additionalinvestment of $100,000 will be considered. Thisexpansion could generate cash flows with indicatedprobabilities as follows: $120,000 (0.3),$140,000 (0.3), and $175,000 (0.4). If expansionis not chosen, the current size will be maintainedwith anticipated sales to continue. Assume thereare no salvage values on any investments. Use thedescription given and a 15% per year return to dothe following: (a) Construct a decision tree including all valuesand probabilities. (b) Determine the expected PW values at theexpansion/no expansion decision nodeafter 2 years provided sales are up. (c) Determine what decision should be madenow to offer the greatest return possible forChemTech. (d ) Explain in words what would happen to theexpected values at each decision node if theplanning horizon were extended beyond3 years and all cash flow values continued asforecasted in the description.