Lecture 13

Case discussion & Problem solving

 Case-study: Handstar Inc.
1. Which projects would you recommend Handstar pursue based on the NPV
approach?
2. Assume the founders weigh a project’s NPV twice as much as both
obtaining/retaining a leadership position and making use of the Web. Use the
weighted factor scoring method to rank these projects. Which projects would you
recommend Handstar pursue?
3. In your opinion is hiring an additional software development engineer justified?
NPV of costs and benefits
Present Value Table
 Practice set: Decision tree
Q1 Colaco currently has assets of $150,000 and wants to decide whether to market a new chocolate-flavored
soda, Chocola. Colaco has three alternatives:
 Alternative 1 Test market Chocola locally, then utilize the results of the market study to determine whether or
not to market Chocola nationally.
 Alternative 2 Immediately (without test marketing) market Chocola nationally.
 Alternative 3 Immediately (without test marketing) decide not to market Chocola nationally.
 In the absence of a market study, Colaco believes that Chocola has a 55% chance of being a national success
and a 45% chance of being a national failure. If Chocola is a national success, Colaco’s asset position will
increase by $300,000, and if Chocola is a national failure, Colaco’s asset position will decrease by $100,000.
 If Colaco performs a market study (at a cost of $30,000), there is a 60% chance that the study will yield
favorable results (referred to as a local success) and a 40% chance that the study will yield unfavorable results
(referred to as a local failure). If a local success is observed, there is an 85% chance that Chocola will be a
national success. If a local failure is observed, there is only a 10% chance that Chocola will be a national
success. If Colaco is risk-neutral (wants to maximize its expected final asset position), what strategy should the
company follow?
Solution: Colaco’s Decision Tree (Risk-Neutral)
 Q2
 An art dealer’s client is willing to buy the painting Sunplant at $50,000. The dealer can buy the
painting today for $40,000 or can wait a day and buy the painting tomorrow (if it has not been sold)
for $30,000. The dealer may also wait another day and buy the painting (if it is still available) for
$26,000. At the end of the third day, the painting will no longer be available for sale. Each day, there
is a .60 probability that the painting will be sold. What strategy maximizes the dealer’s expected
profit?