Nebraska Pharmaceuticals Company (NPC) is considering a project that has an up-front cost at t = 0 of $1,500. (All dollars in this problem are in thousands.) The projects subsequent cash flows are critically dependent on whether a competitor%u2019s product is approved by the Food and Drug Administration. If the FDA rejects the competitive product, NPC's product will have high sales and cash flows, but if the competitive product is approved, that will negatively impact NPC. There is a 75% chance that the competitive product will be rejected, in which case NPC's expected cash flows will be $500 at the end of each of the next seven years (t = 1 to 7). There is a 25% chance that the competitor's product will be approved, in which case the expected cash flows will be only $25 at the end of each of the next seven years (t = 1 to 7). NPC will know for sure one year from today whether the competitor's product has been approved.
NPC is considering whether to make the investment today or to wait a year to find out about the FDA%u2019s decision. If it waits a year, the project%u2019s up-front cost at t = 1 will remain at $1,500, the subsequent cash flows will remain at $500 per year if the competitor%u2019s product is rejected and $25 per year if the alternative product is approved. However, if NPC decides to wait, the subsequent cash flows will be received only for six years (t = 2 ... 7).
Assuming that all cash flows are discounted at 10%, if NPC chooses to wait a year before proceeding, how much will this increase or decrease the project%u2019s expected NPV in today%u2019s dollars (i.e., at t = 0), relative to the NPV if it proceeds today?
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