[Q7-Q10 related] Q9. Hope Corporation is considering a proje…
[Q7-Q10 related] Q9. Hope Corporation is considering a project that has an up-front after tax cost at t = 0 of $800,000. The project’s subsequent cash flows critically depend on whether its products become the industry standard. There is a 80 percent chance that the products will become the industry standard, in which case the project’s expected after- tax cash flows will be $700,000 at the end of each of the next two years (t = 1,2). There is a 20 percent chance that the products will not become the industry standard, in which case the after-tax expected cash flows from the project will be $200,000 at the end of each of the next two years (t = 1,2). Hope will know for sure one year from today whether its products will have become the industry standard. It is considering whether to make the investment today or to wait a year until after it finds out if the products have become the industry standard. If it waits a year, the project’s up-front cost at t = 1 will remain at $800,000 (certain cash flow). If it chooses to wait, the estimated subsequent after-tax cash flows will remain at $700,000 per year for two years (t=2,3) if the product becomes the industry standard, and $200,000 per year for two years (t=2,3) if the product does not become the industry standard. There is no penalty for entering the market late. Assume that all risky cash flows are discounted at 10 percent and risk-free rate is 4 percent. If Hope chooses to wait a year before proceeding, what will be the discount rate for the project’s up-front cost $800,000 (certain cash flow) at t = 1 $800,000?
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