Reference no: EM132930455

Question - Nebraska Instruments is considering a project that has an up-front cost at t = 0 of $1,500,000. There is a 75% chance that the project is a success, in which case the expected cash flows will be $500,000 at the end of each of the next seven years (t = 1 ... 7). There is a 25% chance that the project will be a failure, in which case the expected cash flows from the project will be $50,000 at the end of each of the next seven years (t = 1 ... 7). Now assume the firm will know for sure one year from today whether its project is a success or a failure. It is considering whether to make the investment today or to wait a year until after it finds out if the project is a success. If it waits a year, the project's up-front cost at t = 1 will remain at $1,500,000. If it chooses to wait, the subsequent cash flows will remain at $500,000 per year if the product becomes the industry standard, and $50,000 per year if the product does not become the industry standard. However, if it decides to wait, the subsequent cash flows will be received only for six years (i.e., cash flows will be received in each of years 2, 3, 4, 5, 6, and 7). Assume that all cash flows are discounted at 10%. How much is the value of the option to wait?