Traditional NPV vs Decision Sample Clauses

Traditional NPV vs Decision tree analysis Several approaches of deal with uncertainties have been described above. In the following, we will use a simple example to make a deeper understanding of NPV. A petroleum company considers investing in new capacity but it is worried about the size of market opportunity and whether to find new gas field that may fill up that capacity soon. Depending on the outcome, decide whether to invest or not in the future. The initial investment cost is $0.1 million. If the project is successful, this company may get cash flow $0.5 million from year 1 to year 5. Assume the discount rate for both phase of the project is 5% and risk is fully diversifiable so that we can use risk-free rate in this case. The managers would like to know whether invest now or wait one year to get more information and then make a decision. The cost for waiting one year will be decided later. Based on the traditional NPV method, we can get following net present value. T NPV=  Ct (1 r)t  I   Ct
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