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question 11

Essay

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately and that the probability of high or low demand would still be 50%.What is the value of the option to do pilot production and test marketing?

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Definitions:

Enculturation

The process by which individuals learn and adopt the values, customs, and social practices of their culture.

Assimilation

The process by which individuals or groups adopt the culture and norms of the dominant or surrounding society, often losing former cultural traits.

Predictive Validity

The extent to which a score on a scale or test predicts future performance on relevant tasks or outcomes.

Big Five

A model that outlines five major dimensions of human personality: Openness, Conscientiousness, Extraversion, Agreeableness, and Neuroticism.