Part II. (5 points for each) Solve the questions below sequentially. They are designed to start off relatively easy and get progressively harder.

Suppose one of Bulgaria’s mobile phone operators “M-Vivatelenor” is considering a large investment project to launch 6th generation (6G) mobile phone technology in Bulgaria. The cost will be $22 billion in period zero to purchase the necessary capital and inform the possible customers of this service. The pay-back will come in periods one and two. The firm has a weighted-average-cost-of-capital of 10%.

If the acceptance of the new technology (based on the number of paying subscribers) is STRONG, then the firm will receive a net cash flow of $22 billion in period one and $24.2 billion in period two.

If the acceptance of the new technology (based on the number of paying subscribers) is WEAK, then the firm will receive a net cash flow of $11 billion in period one and $12.1 billion in period two.

  1. If M-Vivatelenor believes there is a 50% chance of acceptance being STRONG and a 50% chance of acceptance being WEAK, what is the expected NPV of the project?

V(STRONG) = -22 + (1/1.1)*22 + (1/1.1)^2 * 24.2 = 18

V(WEAK) = -22 + (1/1.1)*11 + (1/1.1)^2*12.1 = -2

EV(6G) = 0.5*18 + 0.5*(-2) = 8

  1. Suppose the technology was just launched in Serbia by another telecom company, which has proprietary (meaning “secret”) data on how well the technology was accepted there. Suppose M-Vivatelenor believes that the response of Bulgarians is likely to be the same as the response of Serbians. If the response of Serbians is STRONG, then M-Vivatelenor believes that the chance of the STRONG response of Bulgarians is 66-2/3% (and the chance of WEAK response is 33-1/3%.) If the response of Serbians was WEAK, then the chance of a STRONG response by Bulgarians is 33-1/3%.

If M-Vivatelenor can pay money to the Serbian operator to find out what the response was to the new technology in Serbia, what is the maximum amount it should consider paying for this information?

If the Serbian response is STRONG, then the revised EV(6G) is:

EV(6G) = (2/3)*18 + (1/3)*(-2) = 11-1/3

If the Serbian response is WEAK, then the revised EV(6G) is:

EV(6G) = (1/3)*18 + (2/3)*(-2) = 4-2/3

Notice that the project has a positive NPV before checking the Serbian results, and also a positive NPV no matter what the response in Serbia was.This means the Bulgarian company would not change its course of action no matter what happened in Serbia, so the information has zero value.

  1. Suppose the 7th generation (7G) of mobile technology is also under development. The technology will be ready to launch in period one. Running a 7G system will require the use of the same radio spectrum as 6G, so therefore launching 7G will require cancellation of 6G service. If M-Vivatelenor decides that it wants to launch 7G after it has 6G up and running, it will incur cancellation and compensation costs of $5 billion associated with the termination of 6G service, and it will not receive the 6G revenues from period 2. (It will not incur these costs if it launches 7G without launching 6G.)

In words, describe how does the prospect of 7G service affects the valuation of the launch of 6G.

If the company believes it will (under some circumstances) launch 7G, then it must take into account how this will affect its returns on the 6G project at the time it makes the decision to launch 6G. The calculation of NPV of the 6G project should include the cancelation costs and lost revenue in the circumstances in which 7G is launched.

  1. Suppose that if M-Vivatelenor wants to switch from a 6G system to a 7G system, the extra capital expenditure will be $10 billion in period one with a 50% chance of a net cash flow of $33 billion in period 2 and a 50% chance of a net cash flow of $44 billion in period 2. (No cash flows beyond period two.) The net cash flow from 7G is independent of the launch or not-launch of 6G, and is independent of whether the response of consumers to 6G was STRONG or WEAK.

If M-Vivatelenor has no information from the Serbian operator about the response of Serbian customers to 6G, what is the new NPV of the 6G project?

In period one (when the decision to launch 7G is made) the company will know whether G6 is STRONG or WEAK. If STRONG and 7G is launched, then the period zero value will be:

V(6G-STRONG-w-7G) = -22 + (1/1.1)*[22 + (-5) + (-10) ] + (1/1.1)^2 * (.5*33 + .5*44)

V(6G-STRONG-w-7G) = 16.2 Notice that this is less than V(6G-without-7G) above, so if G6 is STRONG, the company won’t want to launch 7G.

V6G-WEAK-w-7G) = -22 + (1/1.1)*[11 + (-5) + (-10)] + (1/1.1)^2 * (.5*33 + .5*44)

V6G-WEAK-w-7G) = 6.2

Therefore the expected NPV of the launch of 6G is:

(0.5)*(16.2) + (0.5)*(6.2) = 11.2

  1. Suppose M-Vivatelenor decides not to launch 6G at all (and has zero expenditures and zero income in period zero) and launches 7G in period one. In this case there are no cancellation and compensation costs, but the capital expenditure will be $20 in period one. What is the NPV (from period zero) of the project “do-not-launch-6G-but-launch 7G-in-period-one”?

V(no-G6) = 0 + (1/1.1)*(-20) + (1/1.1)^2 * (.5*33 + .5*44) =13.6

  1. Suppose the data from the Serbian telecom company just happened to fall into the hands of M-Vivatelenor management, so that the updated probabilities (from question 2) apply. What is the value of the information from the Serbian telecom company?

From question 5, the NPV of not launching G6 at all and waiting to launch G7 (13.6) is greater than the NPV of launching G6 (11.2).

If the company has the Serbian data, then if the Serbian data is strong, and the company launches G6, it receives:

V(G6-w-Serbian-data) = (2/3)*16.2 + (1/3)*(6.2) = 12.9

If the Serbian data is weak, we have:

V(G6-w-Serbian-data) = (1/3)*16.2 + (2/3)*(6.2) = 9.5

Neither of these is better than the “no-G6” choice in question 5. Therefore the decision made by the company does not depend on the Serbian data, which therefore has no value.