Question
ABC is considering a project with an up-front cost at t = 0 of $1,500,000. The project's subsequent cash flows are dependent on whether a
ABC is considering a project with an up-front cost at t = 0 of $1,500,000. The project's subsequent cash flows are dependent on whether a competitor's product is approved by FDA. There is a 75% chance that the competitive product will be rejected, in which case ABC's expected cash flows will be $500,000 at the end of each of the next seven years (t = 1 to 7). There is a 25% chance that the competitor's product will be approved, in which case the expected cash flows will be only $25,000 at the end of each of the next seven years (t = 1 to 7). ABC will know for sure one year from today whether the competitor's product has been approved.
ABC is wondering whether to make the investment today or to wait a year to find out about the FDA's decision. If it waits a year, the project's up-front cost at t = 1 will remain at $1,500,000, and the subsequent cash flows will remain at $500,000 per year if the competitor's product is rejected and $25,000 per year if the alternative product is approved. However, if ABC decides to wait, the subsequent cash flows will be received only for six years (t = 2 to 7). All cash flows are discounted at ABCs WACC of 10%.
If ABC chooses to wait a year, how much will this increase or decrease the project's expected NPV at t = 0, relative to the NPV if it proceeds today? (If waiting a year decreases the NPV, add a negative sign (-) to your answer.) Ignore dollar sign and round your answer to the nearest dollar (e.g., xxx.xxx).
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