Assume that the short-run cost and demand data given in the tables below confront a monopolistic competitor selling a given prod
1 answer:
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Answer:
Investing today is a better option because it has a better NPV of $2.3398 million
Explanation:
Given data :
<u>For Today's Investment </u>
Initial capital investment = $4 million
positive cash flow = $2 million
period of cash flow = 4 years
project cost of capital = 10%
To get the value of This option we have to determine the NPV of this option
NPV = PMT * ----------- (1)
PMT = $2 million
r = 10%
initial cash flow = $4 million
Equation 1 becomes
NPV = (2 * 3.1699 ) - 4
= $6.3398 - $4 = $2.3398 million
<u>For later investment ( 2 years )</u>
initial capital investment = $5 million
90% chance of positive cash flow = $2.1 million
10% chance of positive cash flow = $1.1 million
project cost of capital = 10%
NPV value for a cash flow of $1.1 million
NPV = PMT *
PMT = $1.1 million
initial cash flow = $5 million
r = 10%
Hence NPV = ($1.1 * 3.1699 ) - $5 million
= $3.48689 - $5 million
= - $1.51311
therefore the present NPV = - $1.51311 / 1.21 = -$1.25 million ( therefore no investment will be made )
NPV value for a cash flow of $2.1 million
NPV = PMT *
PMT = $2.1 million
initial cash flow = $5 million
r = 10%
hence NPV = ($2.1 * 3.1699 ) - $5 million
= $6.65679 - $5
= $1.65679
therefore the present NPV = $ 1.65679 / 1.21 = $1.369 million
The Expected NPV value of later investment ( after 2 years )
= $0 * 10% + $1.369 * 90%
= $1.2321 million