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Unformatted text preview: Answer: Suppose the cost of the project is $75 million instead of $70 million, and there is no option to wait. NPV = PV of future cash flows - cost = $74.61 - $75 = -$0.39 million. The project now looks like a loser. Using NPV analysis: NPV = NPV Of Original Project + NPV Of Replication Project = -$0.39 + -$0.39/(1+0.10) 3 = -$0.39 + -$0.30 = -$0.69. Still looks like a loser, but you will only implement project 2 if demand is high. We might have chosen to discount the cost of the replication project at the risk-free rate, and this would have made the NPV even lower....
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
- Spring '08