A company is considering investing in a factory that will have the explicit right to produce a particular product forever. Under current prices, the cash flows generated from product sales are

$100,000. Next year the cash flows from sales will be either $120,000, if market moves favorably, or decline to $80,000, otherwise, and then remain fixed. The cost of the factory is $600,000 and can be constructed in two weeks. Assume that the cost of capital for this investment is 16 percent.

a. What is the investment’s NPV if the company invests now? Should the company invest in the project?

b. Suppose that the company can wait one year before deciding on this investment. What would be the investment’s NPV in that case? What is the value of being able to wait?

c. What is the maximum investment cost that the company would be willing to accept for having the opportunity to wait rather than investing now or never?

In problems 2 to 5, please use the logic of options through decision trees and classical discounted cash flows techniques—rather than a formal real options valuation approach—to approximate the value of options available to the corresponding investments.