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    Advanced Capital Budgeting Class 1

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    sairad1999
    PCPL is deciding whether to test market or directly launch a new beauty product called Nature. It must also decide whether to sell the rights to the product or launch it itself. There are two decisions to make - whether to test market and whether to sell the rights. The optimal decision is to test market the product and then decide whether to launch or sell based on the test results in order to maximize expected NPV. A coal mine manager must decide whether to conduct a soil test before installing a tilting machine. Conducting the test costs Rs. 25,000 but provides information about the soil type which affects machine performance. The optimal decision is to conduct the soil test, as this provides information to maximize the expected NPV

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    Advanced Capital Budgeting Class 1

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    PCPL is deciding whether to test market or directly launch a new beauty product called Nature. It must also decide whether to sell the rights to the product or launch it itself. There are two decisions to make - whether to test market and whether to sell the rights. The optimal decision is to test market the product and then decide whether to launch or sell based on the test results in order to maximize expected NPV. A coal mine manager must decide whether to conduct a soil test before installing a tilting machine. Conducting the test costs Rs. 25,000 but provides information about the soil type which affects machine performance. The optimal decision is to conduct the soil test, as this provides information to maximize the expected NPV

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    ADVANCED CAPITAL BUDGETING CLASS 1

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    PCPL is deciding whether to test market or directly launch a new beauty product called Nature. It must also decide whether to sell the rights to the product or launch it itself. There are two decisions to make - whether to test market and whether to sell the rights. The optimal decision is to test market the product and then decide whether to launch or sell based on the test results in order to maximize expected NPV. A coal mine manager must decide whether to conduct a soil test before installing a tilting machine. Conducting the test costs Rs. 25,000 but provides information about the soil type which affects machine performance. The optimal decision is to conduct the soil test, as this provides information to maximize the expected NPV

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    Download as pdf or txt
    4 views4 pages

    Advanced Capital Budgeting Class 1

    Uploaded by

    sairad1999
    PCPL is deciding whether to test market or directly launch a new beauty product called Nature. It must also decide whether to sell the rights to the product or launch it itself. There are two decisions to make - whether to test market and whether to sell the rights. The optimal decision is to test market the product and then decide whether to launch or sell based on the test results in order to maximize expected NPV. A coal mine manager must decide whether to conduct a soil test before installing a tilting machine. Conducting the test costs Rs. 25,000 but provides information about the soil type which affects machine performance. The optimal decision is to conduct the soil test, as this provides information to maximize the expected NPV

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    of 4

    ADVANCED CAPITAL

    BUDGETING DECISIONS
    CLASS 1
    Advanced Capital Budgeting Decisions Class Work

    Topic Decision Tree

    Question 1:
    Personal Care Products Ltd. (PCPL) is known for its innovative beauty care products. The company’s
    R&D has developed a new product named ‘Nature’ which can fit into its beauty care product
    portfolio. Initially PCPL is facing with a decision whether to test market before launching ‘Nature’
    which will cost Rs.1,500,000. If the product is launched without test marketing the probability of
    success is 0.60 and failure is 0.40.
    If ‘Nature’ is launched by PCPL and proves to be a success, the company’s wealth, in terms of NPV,
    increases by Rs.12,500,000 (before payment of test marketing expenses) while the failure leads to a
    loss, in terms of NPV by Rs.6,250,000, (before payment of test marketing expenses).
    Probability of positive results from test market is 0.52 while that of negative result is 0.48. PCPL’s
    experience shows that when a product is launched following a positive result the probability of
    product’s success is 0.92 and that of failure is 0.08. If the product is launched following a negative
    result the probability of success is 0.25 while that of failure is 0.75.
    The second decision the PCPL faces is whether to sell the commercial rights of ‘Nature’ to some
    other company. It can do so either before or after test marketing. Selling the rights before test
    marketing gives the company an NPV of Rs.4,500,000 while selling the rights after test marketing
    has two outcomes: if the result is positive the company can get an NPV of Rs.9,000,000 (before
    payment of test marketing expenses) and if it is negative it will have an NPV of Rs.2,250,000 (before
    payment of test marketing expenses).
    You are required to
    a. Draw a decision tree, which describes the sequence of decisions
    b. Suggest an optimal decision if PCPL wants to maximize expected NPV.

    2 Sanjay Saraf Educational Institute Pvt. Ltd.


    Advanced Financial Management Class Work

    Question 2:
    A heavy duty tilting machine is to be installed in Bhadra Coal Mines. Manager (Projects) of that
    mines is evaluating a land for its installation. He is considering two alternatives:
    i. To conduct a soil test costing Rs.25,000 to find the nature of underlying soil and decide to install
    or not.
    ii. To start installation on without any soil test.
    The effect of installation can lead to three types of possible performances of the machine, during its
    operation
    i. Good performance i.e., no breakdown or failure
    ii. Moderate Performance i.e. frequent minor breakdowns but no major break downs, and
    iii. Bad performance i.e., frequent major breakdowns.
    If the machine is installed without conducting any soil test the probabilities of the performance of
    the machine is expected to be as follows:
    Performance Probability
    Good 0.2
    Moderate 0.3
    Bad 0.5
    If the manager conducts a soil test, the underlying soil in this case may be one of the following
    types: (i) Filled soil (ii) Soft soil (iii) Rock soil. Rock soil is best for installation of heavy machineries.
    The probabilities to find different types of soil are:
    Type of Soil Probability
    Filled Soil 0.3
    Soft Soil 0.4
    Rock Soil 0.3
    Probability of performance of the machine if installed in these soils are:
    Type of Soil Good Moderate Bad
    Filled Soil 0.05 0.15 0.80
    Soft Soil 0.30 0.40 0.30
    Rock Soil 0.60 0.30 0.10
    The present value of incomes associated with the performance of the machine are as follows:
    Good Rs.2,00,000
    Moderate Rs.80,000
    Bad –Rs.50,000

    3 Sanjay Saraf Educational Institute Pvt. Ltd.


    Advanced Capital Budgeting Decisions Class Work

    You are required to


    a. Draw the Decision Tree Diagram.
    b. Find out the alternative which the manager (projects) should select.
    c. Find out the mean and standard deviation of NPV for this alternative.

    4 Sanjay Saraf Educational Institute Pvt. Ltd.

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