Question

Wilson's Antiques is considering a project with an initial cost today of $10,000. The project has a life of 2 years with cash inflows of $6,500 a year. Should the firm decide to wait one year to commence this project, the initial cost will increase by 5 percent, and the cash inflows will increase to $7,500 a year. What is the value of the option to wait at a discount rate of 10 percent

Answer 1

Answer:

Wilson's Antiques

The value of the option to wait is:

= $1,236.

Explanation:

a) Data and Calculations:

                                      Alternative 1      Alternative 2

                                            Now            Wait (one year after)

Initial cost of project        $10,000              $10,500 ($10,000 * 1.05)

Increase in initial cost                                   5%

Project's estimated life    2 years               2 years

Annual cash inflows        $6,500               $7,500

Discount rate = 10%

PV annuity factor at 10%    1.736                  1.736

Present value of annuity $11,284             $13,020

Net present value             $1,284              $2,520

The value of the option to wait is $1,236 ($2,520 - $1,284)