Question
Lisa would like to construct a store that will cost $15 million. You can begin construction now or wait a year. If you construct the
Lisa would like to construct a store that will cost $15 million. You can begin construction now or wait a year. If you construct the factory now, you will earn $2million at the end of the first year after construction. Those cash flows are expected to grow by 5% per year for the next ten years. The growth rate is then expected to drop to 2% per year forever after that (i.e. from year 11). Your cost of capital is 8%. However, if you wait, your rivals will rush into the market and your initial expected cash flows will drop by 10% when you begin the project two years from now. All the other costs of construction, growth rate numbers, and dates stay constant. The expected volatility of the project is 20%. The risk-free interest is 3% per year. Should you construct the store now or wait one year?
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