Investment Timing Option: Decision$-$Tree Analysis

Wansley Lumber is considering the purchase of a paper company which would require an initial investment of $$300$ million. Wansley estimates that the paper

company would provide net cash flows of $$40$ million at the end of each of the next $20$ years. The cost of capital for the paper company is $13\%.$

a$.$ Should Wansley purchase the paper company?

b$.$ Wansley realizes that the cash flows in Years $1$ to $20$ might be $$32$ million per year or $$48$ million per year, with a $50\%$ probability of each outcome.

Because of the nature of the purchase contract, Wansley can sell the company $2$ years after purchase $($at Year $2$ in this case$)$ for $$270$ million if it no

longer wants to own it$.$ Given this additional information, does decision$-$tree analysis indicate that it makes sense to purchase the paper company?

Again, assume that all cash flows are discounted at $13\%.$

c$.$ Wansley can wait for $1$ year and find out whether the cash flows will be $$32$ million per year or $$48$ million per year before deciding to purchase the

company. Because of the nature of the purchase contract, if it waits and purchases, Wansley can no longer sell the company $2$ years after purchase.

Given this additional information, does decision$-$tree analysis indicate that it makes sense to purchase the paper company? If so$,$ when? Again,

assume that all cash flows are discounted at $13\%.$