Your firm is considering a project with a discount rate of 9%. If you start the

Question

Your firm is considering a project with a discount rate of 9%. If you start the project today, your firm will incur an initial cost of $490 and will receive cash inflows of $365 per year for 3 years. If you instead wait one year to start the project, the initial cost will rise to $530 and the cash flows will increase to $405 a year for the following 3 years. Would your firm be better off starting the project now or waiting to start the project in a year? Explain clearly including an estimate of the value of the option to wait.

Explanation / Answer

If you start the project today, the NPV is calculated as follows:

The NPV of the wait option is as follows:

So the NPV of the wait option is higher at $536.40. Hence it is better to wait for a one year.

Year Cash flow Dsiscounted Cash flow at 9% 0 -490 -490.00 1 365 334.86 2 365 334.86 3 365 334.86 NPV $                 514.59

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