Question

2. Investment timing options Aa Aa Companies often need to choose between making an investment now or waiting until the company can gather more relevant information about the potential project. This opportunity to wait before making the decision is called the investment timing option. Consider the case: General Forge and Foundry Co. is considering a three-year project that will require an initial investment of $41,000. If market demand is strong, General Forge and Foundry Co. thinks that the project will generate cash flows of $28,000 per year. However, if market demand is weak, the company believes that the project will generate cash flows of only $1,250 per year. The company thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak. If the company uses a project cost of capital of 10%, what will be the expected net present value (NPV) of this project? O-$3,936 O-$5,325 O -$4,630 O-$4,399

Answer 1

Expected cash flow from Year 1 to Year 3 = 0.5 * 28000 + 0.5 * 1250 = 14625

Cost of capital = 10%

Initial investment = 41,000

NPV = -$4630

Answer for fill in the blanks,

1. higher

2. higher

3. higher

After delaying project,

NPV = $6,905