1. The firm has a 75% chance if it invests -$1,500 a return of $500 for 7-years, and a 25% chance of returning $25 for 7-years. Assuming that all cash flows are discounted at 10%. Based on the above data, what is the project's net present value?
2. Garner-Wagner is considering a project that is replicable with a $3,000,000 investment at time zero, and returns $500,000 each year for five years and has a discount rate of I/YR = 10%. If Garner-Wagner goes ahead with this project today, it will obtain knowledge that will give rise to additional opportunities 5 years from now (at t = 5). The company can decide at t = 5 whether or not it wants to pursue these additional opportunities.
Based on the best information available today, there is a 35% probability that the outlook will be favorable, in which case the future investment opportunity will have a net present value of $6 million at t = 5. There is a 65% probability that the outlook will be unfavorable, in which case the future investment opportunity will have a net present value of -$6 million at t = 5.
Garner-Wagner does not have to decide today whether it wants to pursue the additional opportunity. Instead, it can wait to see what the outlook is. However, the company cannot pursue the future opportunity unless it makes the $3 million investment today.
What is the estimated net present value of the project, after consideration of the potential future opportunity?
- -$1,104,607
- -$875,203
- $199,328
- $561,947
- $898,205
3. The firm has a 75% chance if it invests -$1,500 a return of $500 for 7-years, and a 25% chance of returning $25 for 7-years. Assuming that all cash flows are discounted at 10%. Calculate the effect of waiting on the project's risk, using the same data. By how much will delaying reduce the project's coefficient of variation? (Hint: Use the expected NPV.)