1. Flexibility with an option to defer:

Suppose you are deciding whether to invest $6,000 one year from now to produce and distribute a new pharmaceutical drug already under development. In the upcoming final development stage, the product will undergo clinical tests on patients for one year for which all investments have already been made, so these tests involve no future cash flows. The trials could have one of two possible outcomes. If the drug proves to be highly effective, it will generate an annual net cash inflow of $500 into perpetuity. If it is only somewhat effective, the annual net cash inflow will be $100 into perpetuity. These outcomes are equally probable. The risk-free rate, say 5 percent.

1. Assuming that the company will realize its first years product sales immediately upon completing the trials and at the end of each year, calculate the NPV for this project
2. Calculate the NPV for this project using DTA with the option to defer?