Damon Corp. is considering a new product that would require an investment of $21

Question

Damon Corp. is considering a new product that would require an investment of $21 million at t= 0. If the new product is well received, then the project would produce after-tax cash flows of $11 million at the end of each of the next 3 years (t= 1,2,3), but if the market did not like the product, then the cash flows would be only $4 million per year, There is a 50% probability that the market will be good. Damon could delay the project for a year while it could conduct a test to determine if demand would be strong or weak. The project's cost and expected annual cash flows (expected at t=0) are the same whether the project is delayed or not. The project WACC is 10.8%. What is the value of the project after considering the investment timing option?

Explanation / Answer

so we just make everything the npv cash flow/(1+wacc)^n. Average the two possible cash flows to determine if profit. -21+7.5/(1.108)+7.5/(1.108)^2+7.5/(1.108)^3 so -2.608

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