Question

A project has been assigned a discount rate of 12 percent. If the project starts immediately, it will have an initial cost of $480 and cash inflows of $350 a year for three years. If the start is delayed one year, the initial cost will rise to $520 and the cash flows will increase to $385 a year for three years. What is the value of the option to wait

Answer 1

Answer: $0.70

Step-by-step explanation:

The value of the option to wait would be calculated thus:

Year Cash flow PVF at 12% PV

0 $-480 1.000 $(480.00)

1 $350 0.893 $312.50

2 $350 0.797 $279.02

3 $350 0.712 $249.12

Then, the Net present value will be:

= 312.50 + 279.02 + 249.12 - 480.00

= $360.64

Year Cash flow PVF at 12%. PV

0 $-1.000 1.000. 0

1 $-520 0.893 $(464.29)

2 $385 0.797 $306.92

3 $385 0.712 $274.04

4 $385 0.636 $244.67

Net present value = $361.34

The value of the option to wait would then be calculated as:

= $361.34 - $360.64

= $0.70