Question
Puddle Ltd is considering investing $50 million in a garbage recycling technology. The cost is the same whether you invest now or in 1 year
Puddle Ltd is considering investing $50 million in a garbage recycling technology. The cost is the same whether you invest now or in 1 year from now. The size of the market depends on the success of government legislation which will be known in exactly one years time. There is a 80% chance the market for the technology will be strong and produce a perpetual free cash flow of $10 million per year; there is a 20% chance it will produce no free cash flow. All yearly cash flows commence one year after making the investment and are assumed to be received at the end of each year. The cost of capital is fixed at 10% per annum (effective annual rate).
Draw a fully labelled decision tree which shows the choices Puddle Ltd faces regarding the investment. (indicate timings, decision-nodes, information- nodes, outcomes, probabilities)
Calculate the value of the technology if Puddle Ltd invests today (i.e. doesnt wait).
Should Puddle Ltd invest today or wait one year to invest? Answer this by calculating the value today and the value of waiting one year in order to learn of the market size before deciding to invest.
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