E11-2 Iridium Corp. has spent $3.5 billion over the past decade developing a sat

Question

E11-2 Iridium Corp. has spent $3.5 billion over the past decade developing a satellite-based telecommunication system. It is currently trying to decide whether to spend an additional $350 million on the project. The firm expects that this outlay will finish the project and will generate cash flow of $15 million per year over the next 5 years. A competitor has offered $450 million for the satellites already in orbit. Classify the firm's outlays as sunk costs or opportunity costs, and specify the relevant cash flows,

Explanation / Answer

1. sunk costs : $3.5B is a sunk cost as it is already incurred. 2. opportunity costs: Addl $350M investment for finishing project is an Opportunity cost. However it will yield $15M pa for next 5 Yrs. So PV of this CF is less than $15*5=$75M. SO NPV = CF0+CF1..+CF5 = -350 + Less than 75 = negative. SO another Opportunity of selling the Satellite for $450 M is a better option. 3. specify the relevant cash flows. If Addl $350M investment is undertaken, $350M will be Cash outflow in Y0. It will result in Annual CF of $15M for next 5 yrs.

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