ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN: 9780190931919
Author: NEWNAN
Publisher: Oxford University Press
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WorldTrans is considering a project that has an up-front cost at t = 0 of $2,700. (All dollars in this problem are in thousands.) The project's subsequent cash flows are critically dependent on whether a competitor's product is approved by the Food and Drug Administration. If the FDA rejects the competitive product, WorldTrans's product will have high sales and cash flows, but if the competitive product is approved, that will negatively impact WorldTrans. There is a 60% chance that the competitive product will be rejected, in which case WorldTrans's expected cash flows will be $750 at the end of each of the next seven years (t = 1 to 7). There is a 40% chance that the competitor's product will be approved, in which case the expected cash flows will be only $50 at the end of each of the next seven years (t = 1 to 7). WorldTrans will know for sure one year from today whether the competitor's product has been approved.

WorldTrans is considering whether to make the investment today or to wait a year to find out about the FDA's decision. If it waits a year, the project's up-front cost at t = 1 will remain at $2,700, the subsequent cash flows will remain at $750 per year if the competitor's product is rejected and $50 per year if the alternative product is approved. However, if WorldTrans decides to wait, the subsequent cash flows will be received only for six years (t = 2 ... 7). In addition, once WorldTrans knows the outcome of the FDA's decision, it will not take on the project if its NPV is negative.

This is a risky project, so a WACC of 16.6% is to be used. If WorldTrans chooses to wait a year before proceeding, what is the value (in thousand) of the timing option today? Do not round intermediate calculations.

Group of answer choices
$12.47
$8.31
$10.39
$9.87
$8.83
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