Cost of Prediction Error-Capital Investment Analysis: Asahi Heavy Equipment Corp. was considering investing in a project with an initial investment cost of $70 million. After studying the market for the product, Asahi estimated that future cash flows would equal $20 million per year for five years. Using a 10 percent discount rate. Asahi concluded that the project met its net present value criteria and signed contracts under which it was committed to go forward with the project. After spending $15 million, Asahi learned that government approvals would delay marketing the product for one full year. If marketing were delayed for a year, the future cash inflows would amount to $20 million per year for only four years instead of the planned five years.

If Asahi decides to complete the project, the company will spend the remaining $55 million in Year 0, but the cash inflows will not begin until Year 2. The contract has a clause which will permit Asahi to end the contract. In this case, Asahi will not be liable for any additional payments, but the contractor will obtain title to the project and Asahi will not be reimbursed for any part of the $15 million already spent.

Required:

a. What are the net present values of the alternatives available to Asahi at this time?

b. If Asahi had reason to believe it was possible that the project could have been delayed, what is the cost of prediction error?

c. Would the cost of prediction error be different if Asahi had spent $10 million on the project so far and had to spend the remaining $60 million in Year 0 to obtain. the reduced cash flows? Why or why not?