DiplomatComDiplomat

question 7

Multiple Choice

Diplomat.comDiplomat.com is considering a project that has an up-front cost of $3 million and is expected to produce a cash flow of $500,000 at the end of each of the next 5 years. The project's cost of capital is 10%.
-Refer to Scenario: Diplomat.com.If Diplomat.com 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 favourable,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 unfavourable,in which case the future investment opportunity will have a net present value of -$6 million at t = 5.Diplomat.com 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?

• A)-$1,104,607
• B)-$875,203
• C)$199,328
• D)$561,947

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Definitions:

Labor Contracts

Agreements between employers and employees or unions that define terms of employment, salaries, benefits, and working conditions.

Short-run Phillips Curve

A graphical representation showing the inverse relationship between unemployment rates and inflation rates in the short-term.

Per-capita Income

The average income earned per person in a certain area, calculated by dividing the area's total income by its total population.

Rational Expectations School

An economic idea that assumes individuals make predictions about the future based on all available information and past experiences in a rational manner.