Example

In order to pursue a project, $$500$ must be spent now

$)=(0$ to explore the project's feasibility. Next year $)=(1,$

the option or decision to continue or abandon the project

will be exercised. The cost of capital is $r=15\%$ per year. If

the project is accepted next year, it will cost an additional

$$1500$ at $t=1$ and will produce cash flows in years $2$

through $6(t=2$ through $t=6$ years$).$

Based on current forecasts, there is a $70\%$ and $30\%$

probability that cash flows CF$2$ through CF$6$ will be $$1000$

and $$400$ per year, respectively. At $t=1,$ we will know

whether the final outcome is $$1000$ or $$400$ per year.