The Following Information Relates to Questions 11 and 12 only
Anker Inc. has come up with a prototype wireless, robotic vacuum cleaner and is ready to go ahead with pilot production and test marketing. The test marketing phase requires an investment of $1 million today. The management team believes that there is a 50% chance that test marketing will be successful and that there will be sufficient demand for the new robotic vacuum. The outcome of test marketing will become clear one year from now. If the test-marketing phase is successful, then Anker Inc. will invest $3 million immediately to build a plant that is expected to generate profits of $500,000 at the end of every year in perpetuity. If test marketing is not successful, Anker Inccan still go ahead and build the new plant but the expected profits would be only $250.000 a the end of every year in perpetuity. Anker Inc.’s cost of capital is 10%.
QUESTION 12 Assume that Anker Inc. has the option to stop the project at any time and sell the project to a large competitor for $500,000. Given the embedded option to sell the project the NPV of the vacuum cleaner project is closest to:
e. None of the above