Reference no: EM133008531

Fly Inc. is considering the launch of a new product but there is some uncertainty about how the product will actually be received. Accordingly your junior analyst has provided you with three sets of market conditions and estimated the probability of each set of circumstances (we learn after two years what will happen from that point forward). Starting the project today would incur costs of $14,000,000, the appropriate cost of capital is 10%. "Good": The product is very well received and profits are estimated to start at $1,400,000 in year 1 with 20% annual growth for 3 years and then slowing to 1% growth into the foreseeable future (at least 30 years). The probability of this occurring is estimated to be 30%. "Average": Profits start at $1,300,000 in year 1 and grow continuously at 1% for the foreseeable future. Probability of occurring is 50% "Poor": Profits start at $900,000 in year 1 but then drop off by 10% each year into the foreseeable future. Probability of occurring is 20%.

Problem a) What is the NPV of this project?

Problem b) If you wait for two years so that there would be no uncertainty about the project's outcome before investing, what is the project's NPV? What is the value of the real option to wait?

Problem c) You have realized if you wait for two years, although there would be no uncertainty about the project's outcome before investing, due to the competition in the market the likelihood of occurrence of the good state drops to 10% while the average state will have a 70% chance of occurrence. The likelihood of the poor state remains the same. What is the project's NPV? What is the value of the real option to wait?