a) A new venture can be started at an investment cost of $1200. The venture would generate a yearly expected free cash flow of either $200 with probability p = 0.5, or $100 with probability 1 p = 0.5 in the first year. The cash flows from that year on would remain at the level attained in the first year in perpetuity. Furthermore, assume that cash flows are uncorrelated with the market (hint: what is its and cost of capital?). The risk-free rate is 10%. Calculate the NPV of this venture if it is started right away.

b) Consider the possibility of waiting 1 year before deciding whether or not to launch the venture described in part (a) at the same initial cost of $1200. Information about the economy and the market for the product would now be sufficient to know fully the future cash flows of the venture. Calculate the NPV of the venture.

c) Consider the case in which learning about expected future cash f1ows requires an actual investment in the venture but that the investment can be staged. Assume that in the venture described in part (a), instead of investing $1200 right away, a pilot project can be started at the cost of $50, and that an additional $1,150 would be required in a year in order generate free cash flows starting from the second year onward. The cost of abandoning the venture in year 1 would be $10. Calculate the NPV of the venture.