Answer Happy

You are the CEO of your
company. The Research and Development
Department of your
company has made a significant progress in a new technology. You
are considering a pilot
program using this technology to produce a brand-new product. This
pilot program will last for
one year and cost £500 million. You believe the pilot program has a
50% chance to succeed
and 50% chance to fail.
If it succeeds, you will invest £3000 million in Year 1 to build up
a complete product line, which will generate free cash flows of
£400 million in perpetuity beginning in Year 2.
If it fails, you can still build the product line but the expected
free cash flows will only be £200 million in perpetuity beginning
in Year 2. Alternatively, you do not build the complete product
line but sell the technology for £300 million, i.e. giving up the
product. The cost of capital is 10%.
Question:
To carry out the pilot program, you need to contact new
suppliers and it is possible that the cost of the pilot program may
be higher than expected. Please do a break-even analysis for your
NPV calculation in Part i, in which the key parameter is the cost
of the pilot program. Discuss how you should use the result of this
break-even analysis in your decision making.