Question

TPG Inc. is evaluating an investment project that lasts for four years. The project has a cost of capital of 15% and requires an initial investment of $5 million today. The size of the annual cash flows will depend on future market conditions. There is a 30% probability that the market conditions will be good, in which case the project will generate free cash flows of $4 million per year during the next four years. There is also a 70% that the market conditions will be bad, in which case the project will only generate free cash flows of $0.5 million per year for the next four years. While TPG is fairly confident about its cash flow forecast, it recognizes that it will have more information about the market conditions if it delays its investment in the project until next year. This delay also means that the firm will give up one year of positive free cash flows. However, if market conditions are good, the firm will proceed with the investment project; if market conditions are bad, the firm will not proceed with the investment project. The firm estimates that the net present value (NPV) of the project without the option to delay and the NPV of the project with the option to delay would be closest to: A. The NPV of the project without the option to delay is -$3.57 million and the NPV of the project with the option to delay is $3.59 million B. The NPV of the project without the option to delay is -$0.57 million and the NPV of the project with the option to delay is $1.08 million C. The NPV of the project without the option to delay is -$3.57 million and the NPV of the project with the option to delay is $1.08 million D. The NPV of the project without the option to delay is - $0.57 million and the NPV of the project with the option to delay is $6.42 million

TPG Inc. is evaluating an investment project that lasts for four years. The project has a cost of capital of 15% and requires an initial investment of $5 million today. The size of the annual cash flows will depend on future market conditions. There is a 30% probability that the market conditions will be good, in which case the project will generate free cash flows of $4 million per year during the next four years. There is also a 70% that the market conditions will be bad, in which case the project will only generate free cash flows of $0.5 million per year for the next four years. While TPG is fairly confident about its cash flow forecast, it recognizes that it will have more information about the market conditions if it delays its investment in the project until next year. This delay also means that the firm will give up one year of positive free cash flows. However, if market conditions are good, the firm will proceed with the investment project; if market conditions are bad, the firm will not proceed with the investment project. The firm estimates that the net present value (NPV) of the project without the option to delay and the NPV of the project with the option to delay would be closest to:
A. The NPV of the project without the option to delay is -$3.57 million and the NPV of the project with the option to delay is $3.59 million
B. The NPV of the project without the option to delay is -$0.57 million and the NPV of the project with the option to delay is $1.08 million
C. The NPV of the project without the option to delay is -$3.57 million and the NPV of the project with the option to delay is $1.08 million
D. The NPV of the project without the option to delay is - $0.57 million and the NPV of the project with the option to delay is $6.42 million

Added by Po-Hsuan W.

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