a. Garner-Wagner is considering investing in a project that requires an investme
ID: 2753863 • Letter: A
Question
a. Garner-Wagner is considering investing in a project that requires an investment of $3,000,000. The project will generate a cash inflow of 500,000 per year for the next 5 years. The cost of capital is 10%. What is the project's net present value?
b. 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
b)The net present value of the future opportunity today=(.35*6,000,000)/1.1^5=1303934.78
net present value of the project, after consideration of the potential future opportunity
=-1104606.615+1303934.78
=199328.17
r 10% N 5 Year(n) Discount Factor Cash Flows Project 1 PV of Cash Flows Project 1 n d=1/(1+r)^n CF1 d*CF1=PV1 0 1 -3000000 -3000000 1 0.909090909 500000 454545.4545 2 0.826446281 500000 413223.1405 3 0.751314801 500000 375657.4005 4 0.683013455 500000 341506.7277 5 0.620921323 500000 310460.6615 NPV of Proj=NPV(=sum of PV1s) -1104606.615Related Questions
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