Damon Corp. is considering a new product that would require an investment of $18
ID: 2676491 • Letter: D
Question
Damon Corp. is considering a new product that would require an investment of $18 million at t = 0. If the new product is well received, then the project would produce after-tax cash flows of $12 million at the end of each of the next 3 years (t = 1, 2, 3), but if the market did not like the product, then the cash flows would be only $6 million per year. There is a 50% probability that the market will be good. Damon could delay the project for a year while it could conduct a test to determine if demand would be strong or weak. The project's cost and expected annual cash flows (expected at t = 0) are the same whether the project is delayed or not. The project's WACC is 8.4%. What is the value of the project after considering the investment timing option?Select the correct answer.
$5,869,080
$5,897,937
$5,859,461
$5,888,318
$5,878,699
Explanation / Answer
Cash flow, year wise in $millions
If well received : -18 12 12 12 : NPV = -18 + 12/1.084 + 12/1.0842 + 12/1.0843 = 12.7033
If not received well: -18 6 6 6 : NPV = -18 + 6/1.084 + 6/1.0842 + 6/1.0843 = -2.648
Average = 0.5(12.7033-2.648) = 7.9435
If Damon waited for a year,
The profit would be 0.5 * (12.7033) / 1.084 (at present value) = 5.8594
Hence the Value is $5,859,461
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