Garner-Wagner has a project that produces the following cash flows: CF 0 = 3,000,000; CF15 = 500,000; and has a discount rate of I/YR = 10. CF0 =…

Garner-Wagner has a project that produces the following cash flows: CF 0 = −3,000,000;

CF1−5 = 500,000; and has a discount rate of I/YR = 10. CF0 = −3,000,000; CF1−5 = 500,000;

I/YR = 10. If Garner-Wagner goes ahead with this project today, it will obtain knowledge that

will give rise to additional opportunities 5 years from now (at t = 5). The company can

decide at t = 5 whether or not it wants to pursue these additional opportunities. Based on

the best information available today, there is a 35% probability that the outlook will be

favorable, in which case the future investment opportunity will have a net present value of

$6 million at t = 5. There is a 65% probability that the outlook will be unfavorable, in which

case the future investment opportunity will have a net present value of -$6 million at t = 5.

Garner-Wagner does not have to decide today whether it wants to pursue the additional

opportunity. Instead, it can wait to see what the outlook is. However, the company cannot

pursue the future opportunity unless it makes the $3 million investment today. What is the

estimated net present value of the project, after consideration of the potential future

opportunity?

$1,104,6

07

$875,203

$199,328

$561,947

$898,205

SolutionYear012345I/YRNPV Cash Flow-3,000,000500,000500,000500,000500,000500,00010%-1104606.62 If at t = 5 the firm’s technology is not successful, the firm will choose not to do…

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