Question
In: Finance
Your firm has an opportunity to invest in a project that costs $800 and you expect...
Your firm has an opportunity to invest in a project that costs $800 and you expect it to return two payments of 500 per year. The interest rate of the project is 10%. The current NPV of project is $67.77.
You also have the option to wait one year to invest the $800. If you wait you will know more and can revise your expectations such that you either expect to return two payments of $750 with a probability of 0.1 or alternatively two payments of $300 (the probability of this is equal to 1 minus the probability of the first result). The interest rate of the project is still 10%.
What is the current present value of the NPV if they choose to wait?
Solutions
Expert Solution
| If we wait for 1 year | |||
| Initial cost in year 1 | 800 | $ | |
| Interest rate | 10% | ||
| Probability | Expected cashflow | ||
| Year | 10% | 90% | |
| 1 | 750 | 300 | 345 |
| 2 | 750 | 300 | 345 |
| a | b | a*b | |
| Year | Cashflow | PV factor 10% [1/(1+r)]^n | PV |
| 1 | (800.00) | 0.909 | (727.27) |
| 2 | 345.00 | 0.826 | 285.12 |
| 3 | 345.00 | 0.751 | 259.20 |
| Current NPV of project | (182.95) | ||
| Conclusion | |||
| Current NPV of project if they choose to wait is -182.95 $ | |||
| So they should not wait for 1 year | |||
| Project should start immediately since it have an NPV of 67.77$ | |||
| Notes: | |||
| NPV = Discounted inflow - Initial investment | |||
| Rate of return is 10% | |||
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