Engineering Economy 7th Edition by Leland Blank ,Anthony Tarquin

Exercise 10

A company that is considering adding a new product line has determined that the first cost would be $80 million. The company is not sure about how the product will be received, so it has projected revenues using optimistic, most likely, and pessimistic estimates of $35 million, $25 million, and $10 million, respectively, with equal probability for each. Instead of expanding now, the company could implement a test program for 1 year in a limited area that will cost $4 million. (The full-scale project will still cost $80 million if implemented after the test program is over.) This will provide the company with the option to move forward or cancel the project. The criterion identified to move ahead with full-scale implementation is that revenues must exceed $900,000. In this case, the pessimistic estimate will be eliminated, and equal probability will be placed on the remaining revenue projections. If the company uses a 5-year planning horizon and a MARR of 12% per year, should the company go ahead with the full-scale project now or take the option to implement the test program for 1 year