Unani Laboratories Limited (ULL) is considering a project for a new type of a herbal medicine which would provide immunity against viruses such as Covid-19. The cost of the project is PKR 60 million. The future cash flows of the project depend on the demand for the medicine, which is uncertain. The company believes that there is a 25 percent chance that demand for the new medicine will be very high, in which case the project will generate cash flows of PKR 35 million each year for 3 years. There is a 50 percent chance of average demand with cash flows of PKR 30 million each year for 3 years. There is a 25 percent chance that the demand will be low and annual cash flows will be only PKR 10 million each year for three years. The cost of capital is 13%. ULL could accept the project and implement it immediately. The company has acquired a patent on the medicine. Therefore, ULL can also choose to delay the implementation of the project by one year, when more information about demand will be available. If delayed by one year, the investment cost will still be PKR 60 million and the project is expected to generate the same cash flows as indicated above, but each cash flow will be pushed back one year. If ULL waits for one year, it will know which of the demand conditions, hence which set of cash flows, will exist. The company will make the investment only if demand is sufficient to provide a positive NPV. Required A. What is the project’s Expected NPV if the project is implemented immediately?
Unani Laboratories Limited (ULL) is considering a project for a new type of a herbal
medicine which would provide immunity against viruses such as Covid-19. The cost of
the project is PKR 60 million. The future cash flows of the project depend on the
demand for the medicine, which is uncertain. The company believes that there is a 25
percent chance that demand for the new medicine will be very high, in which case the
project will generate cash flows of PKR 35 million each year for 3 years. There is a 50
percent chance of average demand with cash flows of PKR 30 million each year for 3
years. There is a 25 percent chance that the demand will be low and annual cash flows
will be only PKR 10 million each year for three years. The cost of capital is 13%. ULL
could accept the project and implement it immediately. The company has acquired a
patent on the medicine. Therefore, ULL can also choose to delay the implementation of
the project by one year, when more information about demand will be available. If
delayed by one year, the investment cost will still be PKR 60 million and the project is
expected to generate the same cash flows as indicated above, but each cash flow will be
pushed back one year. If ULL waits for one year, it will know which of the demand
conditions, hence which set of cash flows, will exist. The company will make the
investment only if demand is sufficient to provide a positive
Required
A. What is the project’s Expected NPV if the project is implemented immediately?
B. If ULL decides to wait for one year, what would be the Expected NPV?
Use Decision tree analysis to answer this question.
C. Should the company wait for one year, why or why not?
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