You are considering a project which has been assigned a discount rate of 8 percent.If you start the project today,you will incur an initial cost of $480 and will receive cash inflows of $350 a year for three years.If you wait one year to start the project,the initial cost will rise to $520 and the cash flows will increase to $385 a year for three years.What is the value of the option to wait?

Question

Quizplus · Accepted Answer

The value of the option to wait is the difference between the NPV of the project if you wait one year to start and the NPV of the project if you start today.The NPV of the project if you wait one year to start is:```NPV = -520 + 385/(1.08) + 385/(1.08)^2 + 385/(1.08)^3= $17.08```The NPV of the project if you start today is:```NPV = -480 + 350/(1.08) + 350/(1.08)^2 + 350/(1.08)^3= $0.23```Therefore, the value of the option to wait is:```$17.08 - $0.23 = $15.23```

You Are Considering a Project Which Has Been Assigned a Discount