The Wing Foot Shoe Company is considering a three-year project to market a running shoe based on new technology. Success depends on how well consumers accept the new idea and demand the product. Demand can vary from great to terrible, but for planning purposes management has collapsed that variation into just two possibilities: good and poor. A market study indicates a 60% probability that demand will be good and a 40% chance that it will be poor.
It will cost $5 million to bring the new shoe to market. Cash flow estimates indicate inflows of $3 million per year for three years at full manufacturing capacity if demand is good, but just $1.5 million per year if it’s poor. Wing Foot’s cost of capital is 10%. Analyze the project and develop a rough probability distribution for NPV.