Garner-Wagner has a project that produces the following cash flows: CF0 = 3,000,
ID: 2751779 • Letter: G
Question
Garner-Wagner has a project that produces the following cash flows: CF0 = 3,000,000; CF15 = 500,000; and has a discount rate of I/YR = 10. CF0 = 3,000,000; CF15 = 500,000; I/YR = 10. If Garner-Wagner goes ahead with this project today, it will obtain knowledge that will give rise to additional opportunities 5 years from now (at t = 5). The company can decide at t = 5 whether or not it wants to pursue these additional opportunities. Based on the best information available today, there is a 35% probability that the outlook will be favorable, in which case the future investment opportunity will have a net present value of $6 million at t = 5. There is a 65% probability that the outlook will be unfavorable, in which case the future investment opportunity will have a net present value of -$6 million at t = 5. Garner-Wagner does not have to decide today whether it wants to pursue the additional opportunity. Instead, it can wait to see what the outlook is. However, the company cannot pursue the future opportunity unless it makes the $3 million investment today. What is the estimated net present value of the project, after consideration of the potential future opportunity?
Explanation / Answer
Estimated NPV at year 5 = Favorable NPV at year 5*Probability + not conituing *probability
Estimated NPV at year 5 = 6000000*35% + 0*65%
Estimated NPV at year 5 = 2100000
After consideration of the potential future opportunity
Estimated net present value of the project today = -Initial investment + Annual Cash flow for 5 year*(1-(1+r)^-n)/r +Expected Estimated NPV at year 5/(1+r)^n
Estimated net present value of the project today = -3000000 + 500000*(1-(1+10%)^-5)/10% + 2100000/(1+10%)^5
Estimated net present value of the project today = $ 199,328
Answer
c)$199,328
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