a. Project X has an up-front cost of $20 million. The project is expected to produce after-tax cash flows of $7.5 million at the end of each of the next 3 years (t = 1, 2, and 3). The project has a WACC=10%. What is the projects NPV?

b. However, if the company waits a year they will find out more about the projects expected cash flows. If they wait a year, there is a 50% chance the market will be strong and the expected cash flows will be $10 million a year for 3 years. There is also a 50% chance the market will be weak and the expected cash flows will be $5 million a year for 3 years. The projects initial cost will remain $20 million, but it will be incurred at t = 1 only if it makes sense at that time to proceed with the project. So, should the company go ahead with the project today or wait for more information?

Wait 1 year; cash flows are shown as below in millions on time line:

Wait 1 year; cash flows are shown as below in millions on time line:

10%

0 1 2 3 4

Strong demand | | | | |

50% Prob. 0 -20 10 10 10

Weak demand | | | | |

50% Prob. 0 -20 5 5 5