A risk-neutral decision-maker is considering making an irreversible investment costing $1200. The proposed project has no operating costs, and will produce 100 units of output per annum in perpetuity, starting one year after the investment cost is incurred. The price at which the output can be sold will either be $1 per unit, with probability 0.5, or $3 per unit, with probability 0.5. The rate of interest is 10% per annum.

i What is the expected NPV of the project if it is undertaken now?

ii One year from now the price at which the output can be sold will be known with certainty. The project can be delayed for one year, in which case the investment cost is incurred a year from now, and the flow of output starts two years from now.

iii What is the expected NPV of the project now if it is to be delayed for one year pending the receipt of the price information?

iv Should the project be delayed for a year? Explain why or why not.

v What is the value now of the option of delaying the project? Explain.