Cosgrove Technologies is considering a project that has an up-front cost of $3 million and produces an expected cash flow of $500,000 at the end of each of the next five years. The project's cost of capital is 10 percent.
If Cosgrove goes ahead with this project today, the project will create additional opportunities five years from now (t = 5). The company can decide at t = 5 whether or not it wants to pursue these additional opportunities. Based on the best information that is available today, the company estimates that there is a 35 percent chance that its technology will be successful, in which case the future investment opportunities will have a net present value of $6 million at t = 5. There is a 65 percent chance that its technology will not succeed, in which case the future investment opportunities will have a net present value of -$6 million at t = 5. Cosgrove does not have to decide today whether it wants to pursue these additional opportunities. Instead, it can wait until after it finds out if its technology is successful. However, Cosgrove cannot pursue these additional opportunities in the future unless it makes the initial investment today. What is the estimated net present value of the project today, after taking into account the future opportunities?
A) $199,328
B) $561,947
C) $898,205
D) -$1,104,607
E) -$2,222,265

Question

Quizplus · Accepted Answer

The correct answer is A. The estimated net present value of the project today, after taking into account the future opportunities, is $199,328. This is calculated as follows:NPV = -3,000,000 + (500,000 / 0.10) * (1 - (1 / (1 + 0.10)^5)) + (0.35 * 6,000,000 / (1 + 0.10)^5) + (0.65 * -6,000,000 / (1 + 0.10)^5)= -3,000,000 + 2,283,200 + 1,141,600 - 1,680,000= $199,328

Cosgrove Technologies Is Considering a Project That Has an Up-Front