Chapter 3

Q. 3.PP.39

A company has the following estimates of the present values of the future cash flows after taxes associated with the investment proposal, concerned with expanding the plant capacity. It intends to use a decision-tree approach to get a clear picture of the possible outcomes of this investment. The plant expansion is expected to cost Rs 3,00,000. The respective PVs of future CFAT and probabilities are as follows:
Advise the company regarding the financial feasibility of the project.

PV \>of \>future\> CFAT
Probabilities Without\>expansion With\>expansion
0.2 Rs 2,00,000 Rs 3,00,000
0.4      2,00,000       5,00,000
0.4      3,50,000      9,00,000


Verified Solution

The relevant computations are depicted in Figure 6.5.

Recommendation: The expected NPV with plant expansion and without expansion is Rs 3,20,000 and Rs 2,60,000 respectively. Therefore, the company is advised to expand the plant capacity.