If the interest rate is 8 per year what decision would you m

If the interest rate is 8?% per? year, what decision would you make based on the decision tree diagram in the figure? below?

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$210,000 profit per year for five years, starting at EOY 4 - $1,000,000 at EOY 3 Introduce New Product (0.7) $270,000 profit per year for five years, starting at EOY 4 Do Nothing $0 profit/yr. for 8 years Year 0

Solution

R = 8%

When product is introduced and probability is .3:

Present value of cash inflows = (210000*(1-1/1.08^5)/.08)*(1/1.08^4)

Present value of cash inflows = $616299.8

When product is introduced and probability is .7:

Present value of cash inflows = (270000*(1-1/1.08^5)/.08)*(1/1.08^4)

Present value of cash inflows = $792385.5

Expected value of PV of cash inflows = .3*616299.8 + .7*792385.5 = $739559.8

Present value of the investment = 1000000/1.08^3 = $793832.2

So, net present worth of the project = 739559.8 - 793832.2

net present worth of the project= -$54272.4

Since the net present worth of the product launch project is negative ( -$54272.4) , then it is good to “do nothing”.