Question Details

ABC is considering a project that has an up-front after tax costat t = 0 of $1,000,000. The project’s subsequent cash flowscritically depend on whether its products become the industrystandard. There is a 70 percent chance that the products willbecome the industry standard, in which case the project’s expectedafter- tax cash flows will be $900,000 at the end of each of thenext three years (t = 1,2,3). There is a 30 percent chance that theproducts will not become the industry standard, in which case theafter-tax expected cash flows from the project will be $200,000 atthe end of each of the next three years (t = 1,2,3). NI will knowfor sure one year from today whether its products will have becomethe industry standard. It is considering whether to make theinvestment today or to wait a year until after it finds out if theproducts have become the industry standard. If it waits a year, theproject’s up-front cost at t = 1 will remain at $1,000,000 (certaincash flow). If it chooses to wait, the estimated subsequentafter-tax cash flows will remain at $900,000 per year if theproduct becomes the industry standard, and $200,000 per year if theproduct does not become the industry standard. There is no penaltyfor entering the market late. Assume that all risky cash flows arediscounted at 8 percent and risk-free rate is 5 percent.

Please show work so I can learn.

1) What is the expected NPV of the project if NIproceeds today?

2) If NI chooses to wait a year before proceeding, whatwill be the project’s new NPV?