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".
First we need to determined the NPV of the follow up project which can only be initiated if the first project is successful. The Expected PV of future cash flows for the follow up project ...
The solution provides a very good response to the question. It explains in detail why the project should be taken up by the management. The answer is very detailed with all the calculations. Overall, an excellent response.