A project has been assigned a discount rate of 12 percentIf

. A project has been assigned a discount rate of 12 percent.Ifthe 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?

Solution

Year Cash flow PV Factor at 12% PV 0 ($480) 1 ($480) 1 $350 0.893 312.55 2 $350 0.797 278.95 3 $350 0.712 249.2 NPV 360.7 Year Cash flow PV Factor at 12% 0 0 1 0 1 ($520) 0.893 -464.36 2 $385 0.797 $306.85 3 $385 0.712 $274.12 4 $385 0.636 $244.86 NPV 361.47 Value of option to wait= $361.47- $360.7= $.77