Question

Your firm is considering a project with a discount rate of 9%. If you start the projecttoday, your firm will incur an initial cost of $490 and will receive cash inflows of$365 per year for 3 years. If you instead wait one year to start the project, the initial cost will rise to $530 and the cash flows will increase to $405 a year for the following 3 years. Would your firm be better off starting the project now or waiting to start the project in a year? Explain clearly including an estimate of the value of the option to wait.

Answer 1

If the company start the project today then NPV of the project,

Year Cash Flow PV of Cash flow

0 -490 -490

1 365 365/1.09= 334.86

2 365 365/1.09^2 = 307.21

3 365 365/1.09^3= 281.85

NPV = 433.92

NPV of Project0= $ 433.92

If a company start a project after one year,

Year Cash Flow PV of Cash flow

0 0 0

1 -530 -530/1.09= -486.24

2 405 405/1.09^2 =340.88

3 405 405/1.09^3 = 312.73

4 405 405/1.09^4 = 286.91

NPV = 454.28

NPV of Project1= $ 454.28

Here for project start after one year has more Net Present Value of cash flow compared to which start now.

So, Starting a project after one year is more profitable.