Your research and development division has just invented a new type of screen for smartphones; you have given the go ahead to try to produce it commercially. It will take five years to find out whether the screen is commercially viable, and you estimate that the probability of its success is 30%. Development will cost 7 million per year, paid at the beginning of each year. If development is successful and you decide to produce the screen, a factory extension will be built immediately. The factory will cost 1,500 million to put in place and will generate profits of 90 million at the end of every year in perpetuity. Assume that the current five-year risk-free interest rate is 9.2% per year, and the yield on a perpetual risk-free bond will be 10.0%, 9.0%, 8.0%, 7.0%, or 4.0% in five years. Assume that the risk-neutral probability of each possible rate is the same.

What is the value of this project in year 4?

What is the value of this project today? Should you undertake the project?

Suppose that you can sell the screen prototype to a competitor for 50million in year 5. This option is available regardless of whether the development stage succeeds or not. Explain whether you should undertake the project in that case.