Solution (Excel version) to ACCA Conditional Probability Example
The example below is prepared by ACCA, extracted from the topic of conditional probability under Advanced Financial Management (Paper P4). Please refer to the link below for details.
I have prepared a Microsoft Excel version of the solution.
Problem
Brisport Master Motor Co (Brisport) designs, manufactures and sells a range of components for the motor car industry. The design team has recently designed a new component for inclusion into hybrid cars. The component greatly enhances the battery ‘road time’ and therefore reduces the frequency with which the battery has to be recharged.
The company can either sell the design now, for its initial market value of $400,000, or attempt to develop the design into a marketable product, which can be supplied to the motor industry. This development would have an initial outlay of $300,000 now and the component would take one year to be developed. In such a fast moving market, the component is likely to have a market life as a saleable product of just five years after development.
If the company decides to develop the component, the chances of succeeding in developing the design into the marketable product are 80%. If the attempt to develop fails, the design can only be sold, in one year’s time, for half of its earlier market value.
If the attempt to develop the design succeeds the company has a choice of either selling both the design and the rights to sell the developed component, or marketing the component themselves.
Selling the design would yield $300,000 in one year’s time and $160,000 in royalty payments for each of the five years thereafter (years 2 to 6).
If the component is marketed by Brisport then there is a 75% probability that the product will be popular and will generate cash inflows of $440,000 per annum but there is a 25% probability that it will be unpopular and it will generate cash outflows of $55,000 per annum. Both cash flow figures are also for each of years 2 to 6.
Brisport uses a weighted average cost of capital of 7% to discount its future cash flows. The management of Brisport Master Motor Co seeks your advice as to their best course of action.
Situation (Excel)
Solution (Excel)
