A project has been assigned a discount rate of 12 percent.If the project starts immediately,it will have an initial cost of $480 and cash inflows of $350 a year for three years.If the start is delayed one year,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 it is delayed one year and the NPV of the project if it is started immediately. The NPV of the project if it is delayed one year is:$$NPV = -520 + 385/(1.12) + 385/(1.12)^2 + 385/(1.12)^3 = $1.08$$The NPV of the project if it is started immediately is:$$NPV = -480 + 350/(1.12) + 350/(1.12)^2 + 350/(1.12)^3 = $0.70$$Therefore, the value of the option to wait is $1.08 - $0.70 = $0.38.

A Project Has Been Assigned a Discount Rate of 12