Investment strategy for a technology company
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You have been retained to evaluate a major investment for a technology company. The cost of the project is $100 million. If the project is successful, it will generate expected profits of $15 million per year forever,which has a present value of $150 million. However, there is a 50% chance that the project will be a complete failure, in which case it will generate no cash flows. Moreover, if the project is successful there will be a follow-on project that can be initiated the following year. The follow-on project will have a cost of $1 billion, and if things go well it will generate expected cash flows of $150 million per year that last forever and result in a value of $1.5 billion (in Year 1 dollars). If the follow-on project is not successful, it will result in a stream of cash flows with a present value of $900 million. Should the initial project be taken? Explain your recommendation in commonsense terms to your boss, who is not a "techie."
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Solution Summary
The solution examines an investment strategy for a technology company. The solution explains the recommendations in commonsense terms.
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If we are evaluating the first project in isolation, it is not recommended to take up the project as the expected loss from accepting the project is $25. However, we should not evaluate the first project in isolation as it provides us an opportunity to undertake the follow on ...
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