Problem:
Over the past year, you spent $6,000 to open a gourmet cupcake store and have started to generate sales. You are considering spending $1,200 today to develop a flashy advertising campaign. Next year, if the economy is booming, you expect this campaign to result in $4,000 of incremental cash flow (for simplicity, assume the full amount arrives in exactly one year). If the economy is average, $1,500 additional cash flow is expected. But if we are in a recession, no one will want cupcakes and the marketing will have no effect on cash flow. The three economic states are equally likely.
Required:
Question: What is the NPV of this ad campaign if the required rate of return is 14%?
- -677
- -125
- 408
- 772
- 945
- 1200
Note: Explain all steps comprehensively.