Problem:
You have been retained to evaluate a mojor investment for a technology company. The cost of the project is $100 million. If the project is successful, it will generate expected profits of $15 million per year forever, which has a present value of $150 million. However, there is a 50% chance that the project will be a complete failure, in which case it will generate no cash flows. Moreover, if the project is successful there will be a follow-on project that can be initiated the following year. The follow-on project will have a cost of $1 billion, and if things go well it will generate expected cash flows of $150 million per year that last forever and result in a value of $1.5 billion (in Year 1 dollars). If the follow-on project is not successful, it will result in a stream of cash flows with a present value of $900 million. Should the initial project be taken? Explain your recommendation in commonsense terms to your boss, who is not a "techie."