09 Jul Classic Products
Classic Products is evaluating a possible investment in a new plant costing $1000. By the end of a year they
will know whether cash flows will be $140 a year in perpetuity or only $50 a year, but in either case the first
cash flow will not occur until year 2. Alternatively, they would be able to sell their plant in year 1 for $700
($800, if things go well). They assess a 70 percent chance that the project will turn out well and a 30 percent
chance it will turn out badly. Their opportunity cost of funds is 10 percent. What should they do? Use a
decision tree approach.
Are there limitations of the decision tree? explain.
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