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You are considering a project which has been assigned a discount rate of 5 percent. If you start the project today, you will incur an initial cost of $4,100 and will receive cash inflows of $2,900 a year for 2 years. If you wait one year to start the project, the initial cost will rise to $4,320 and the cash flows will increase to $3,257 a year for 2 years. What is the value of the option to wait

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jepessoa

Answer:

$361.14

Explanation:

start the project today:

initial outlay = -$4,100

cash flow year 1 = $2,900

cash flow year 2 = $2,900

NPV = -$4,100 + $5,392.29 = $1,292.29

if you start the project in one year:

initial outlay year 1 = -$4,320

cash flow year 2 = $3,257

cash flow year 3 = $3,257

NPV year 1 = -$4,320 + $6,056.10 = $1,736.10

value of option to wait = ($1,736.10 / 1.05) - $1,292.29 = $361.14

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