Marichal Motors is considering an investment in a proposed project. Rather than

Question

Marichal Motors is considering an investment in a proposed project. Rather than making the investment today, the company wants to wait a year to collect additional information about the project. If Marichal waits a year, it will not have to invest any cash flows unless it decides to make the investment. If it waits, there is a 25% chance the project's expected NPV one year from today will be $10 million, a 50% chance that the project's expected NPV one year from now will be $4 million, and a 25% chance that the project's expected NPV one year from now will be -$10 million. All expected cash flows are discounted at 10%. What is the expected NPV (in today's dollars) if the company chooses to wait a year before deciding whether to make the investment?

Explanation / Answer

Net expected NPV one year from today is given by mutiplying the probability of each chance wiith the expected NPV.

Hence Expected NPV one year from today will be 0.25* 10 + 0.5*4 + 0.25*(-10) = $ 2 Million

Hence NPV today will be $2/(1+0.10) ---> Since it is discounted by 10%

Hence NPV = 2/1.10 = $ 1.82 Million.

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