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You can invest in a risk free technology that requires an
You can invest in a risk-free technology that requires an upfront payment of 1,180,000 and will provide a perpetual annual cash flow of 114,000. Suppose all interest rates will be either 9.9% or 4.7% in one year and remain there forever. The risk-neutral probability that interest rates will drop to 4.7% is 89%. The one-year risk-free interest rate is 8.2% anid today’s rate on a risk-free perpetual bond is 5.1%, the rate on an equivalent bond that is repayable at any time(the callable annuity rate is 8.5%.
a. What is the NPV of investing today?
b. What is the NPV of waiting and investing tomorrow?
c. Verify that the hurdle rate rule of thumb gives the correct time to invest in this case.
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