Asked by Barbara silva on May 20, 2024
Verified
Kanick Corp is evaluating a new venture project and has developed the following decision tree analysis ($M).
Kanick's cost of capital is 12% but a pure play competitor in the new field has been identified with a beta of 1.5. The average stock is returning 14% and treasury bills yield 6%. What is the venture's expected NPV. Discuss its risk characteristics.
Decision Tree Analysis
A graphical technique used for decision-making and risk management, representing different courses of action and their possible outcomes.
Cost Of Capital
The cost of capital represents the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile.
Pure Play
A company that focuses exclusively on a single product or service area.
- Acquire an understanding of the importance of modifying for risk within capital budgeting and the implementation of correct discount rates.
- Realize the importance of decision options in capital budgeting, including the aspects of expansion, abandonment, and the timing of actions.
Verified Answer
CH
Carla HoustonMay 20, 2024
Final Answer : 
The project has an expected NPV of over $9M, which argues for acceptance. However, the probability distribution shows a good chance (12%) of a loss exceeding $7M on a present value basis. Acceptance is likely to turn on whether the firm could survive a loss that large.
The project has an expected NPV of over $9M, which argues for acceptance. However, the probability distribution shows a good chance (12%) of a loss exceeding $7M on a present value basis. Acceptance is likely to turn on whether the firm could survive a loss that large.
Learning Objectives
- Acquire an understanding of the importance of modifying for risk within capital budgeting and the implementation of correct discount rates.
- Realize the importance of decision options in capital budgeting, including the aspects of expansion, abandonment, and the timing of actions.