A professor in the Computer Science department at United States Institute of Technology has just patented a new search engine technology and would like to sell it to you, an interested venture capitalist. The patent has a 17-year life. The technology will take a year to implement (there are no cash flows in the first year) and has an upfront cost of

$100

million. You believe this technology will be able to capture

1.05%

of the Internet search market, and currently this market generates profits of

$1

billion per year. Over the next five years, the risk-neutral probability that profits will grow at

10.1%

per year is

20%

and the risk-neutral probability that profits will grow at

5.1%

per year is

80%.

This growth rate will become clear one year from now (after the first year of growth). After five years, profits are expected to decline

2%

annually. No profits are expected after the patent runs out. Assume that all risk-free interest rates are constant (regardless of the term) at

10.1%

per year.

a. Calculate the NPV of undertaking the investment today.

b. Calculate the NPV of waiting a year to make the investment decision.

c. What is your optimal investment strategy?