When preparing capital budgeting analysis for a new project,Chris Johnson, a chief financial officer at BT Industries, faced adilemma. The project involved a production of new type of shippingcontainers, which were significantly more durable and had aconsiderably longer useful life compared to conventional containersused in the industry. The year was 2009, and the equipmentnecessary for producing the containers was being sold for $900K.Each year, this cost is expected to increase by 20%. The usefullife of the equipment and the project is 5 years. Mr. Johnsonestimated that during a good year, the project will generate netcash flows of $700K per year, while during a bad year, the projectwill lose money, with an expected net cash flow of

$-300K per year.

Because the economy suffered a significant decline just a yearprior, there was uncertainty about the economy in general, and,very much affected by the economy, the demand for shipping andcontainers. Market analysts predicted that uncertainty will remainin 2010 and at this point, in 2009, the likelihood of 2010 being agood year is estimated at 40% and the likelihood of 2010 being abad year is estimated at 60%. However, all uncertainty will getresolved in 2011. The likelihood of 2011 and all subsequent yearsbeing good years (recovery) is 60%, and the likelihood of thesesubsequent years being bad years (recession) is 40%.

Since he has not dealt with uncertainty regarding the futurestate of the economy before, Mr. Johnson is bewildered and asksyour help in determining the course of action regarding thisopportunity. Mr. Johnson has estimated that the WACC for thecompany in certain times has been 10%. Assume that the project hasno tax implications, i.e. the tax rate of 0%.

What is the NPV of investing into the machine in 2009? A:$1109.1

What is the NPV (in year 2009) of delaying the investment until2010? __________________

Should the firm invest in the project in 2009, 2010, or notinvest at all? __________________

Assume that the firm has the possibility to invest in 2009 only.What is the value of knowing in 2009 with certainty the state ofthe world in 2010, with regards to this project? In other words,what is the maximum amount of money the company would pay to knowin 2009 whether 2010 would be a good or a bad year? Explain youranswer.