Wansley Lumber is considering the purchase of a paper company.Purchasing the company would require an initial investment of $300million. Wansley estimates that the paper company would provide netcash flows of $40 million at the end of each year for the next 20years. The cost of capital for the paper company is 13%.
a. Should Wansley purchase the paper company?
b. Wansley realizes that the cash flows in Years 1 to 20 mightbe $30 million per year or $50 million per year, with a 50%probability of each outcome. Wansley can sell the company 2 yearsafter purchase (at Year 2) for $280 million if it no longer wantsto own it. Given this information, does decision-tree analysisindicate that it makes sense to purchase the paper company? Again,assume all cash flow are discounted at 13%
c. Wansley can wait for 1 year and find out whether the cashflows will be $30 million per year of $50 million per year beforedeciding to purchase. Wansley can no longer sell the company 2years after purchase. Does decision-tree analysis indicate that itmakes sense to purchase the paper company? If so, when?
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