The Yoran Yacht Company (YYC), a prominent sailboat builder in Newport, may design a new 30-foot sailboat based on the “winged” keels first introduced on the 12-meter yachts that raced for the America’s Cup.

First, YYC would have to invest $10,000 at t = 0 for the design and model tank testing of the new boat. YYC’s managers believe that there is a 60 percent probability that this phase will be successful and the project will continue. If Stage 1 is not successful, the project will be abandoned with zero salvage value.

The next stage, if undertaken, would consist of making the molds and producing two prototype boats. This would cost $500,000 at t = 1. If the boats test well, YYC would go into production. If they do not, the molds and prototypes could be sold for $100,000. The managers estimate that the probability is 80 percent that the boats will pass testing, and that Stage 3 will be undertaken. Stage 3 consists of converting an unused production line to produce the new design. This would cost $1,000,000 at t = 2. If the economy is strong at this point, the net value of sales would be $3,000,000, while if the economy is weak, the net value would be $1,500,000. Both net values occur at t = 3, and each state of the economy has a probability of 0.5. YYC’s corporate cost of capital is 12 percent.

a. Assume that this project has average risk. Construct a decision tree and determine the project’s expected NPV.

b. Find the project’s standard deviation of NPV and coefficient of variation (CV) of NPV. If YYC’s average project had a CV of between 1.0 and 2.0, would this project be of high, low, or average stand-alone risk?