Elton Cranes is considering production of a new type of crane. The initial cost of the project is $25 million.
There is a 50% probability that demand will be strong, in which case the company will gain annual free cash flows to the firm of $6 million per year for 15 years. Otherwise, the annual free cash flows to the firm will only be $2 million per year.
The company has a weighted average cost of capital of 8%.
Part 1
What is the NPV of the project (in $ million)?
Part 2
Now assume that the company can wait a year to study the demand for the new type of crane. The market research study costs $0.2 million now, will take one year and will reveal if demand will be strong or weak. If the company accepts the project after one year, the magnitude of the cash flows will be the same, but the cash inflows will occur only for 14 years. What is the NPV of the project with the option to delay (in $ million)?
Part 3
What is the value of the option to delay (in $ million)?