Nebraska Instruments (NI) is considering a project that has an up-front after tax cost at t = 0 of $1,000,000. The project’s subsequent cash flows critically depend on whether its products become the industry standard. There is a 60 percent chance that the products will become the industry standard, in which case the project’s expected after- tax cash flows will be $900,000 at the end of each of the next three years (t = 1,2,3). There is a 40 percent chance that the products will not become the industry standard, in which case the after-tax expected cash flows from the project will be $100,000 at the end of each of the next three years (t = 1,2,3). NI will know for sure one year from today whether its products will have become the industry standard. It is considering whether to make the investment today or to wait a year until after it finds out if the products have become the industry standard. If it waits a year, the project’s up-front cost at t = 1 will remain at $1,000,000 (certain cash flow). If it chooses to wait, the estimated subsequent after-tax cash flows will remain at $900,000 per year if the product becomes the industry standard, and $100,000 per year if the product does not become the industry standard. There is no penalty for entering the market late. Assume that all risky cash flows are discounted at 10 percent and risk-free rate is 4 percent.
a) What is the expected NPV of the project if NI proceeds today?
b) If NI chooses to wait a year before proceeding, what will be the project’s new NPV?