You are considering the purchase of an old fire station, which you plan to convert to an indoor playground. The fire station can be purchased for $200,000, and the playground will generate lifetime profits (excluding the cost of the building) of $700,000. (Assume that those profits are all realized one year after opening.) However, there is a 20% chance that the city council will rezone the district to exclude establishments such as yours; a hearing is scheduled for the coming year, and if your building is rezoned, your profit will be zero. Assume that there is no other building currently under consideration.
a. Calculate the net present value of opening the playground today. Note that the cost of purchasing the building today is certain, but the benefits are uncertain.
b. Calculate the net present value today of opening the playground in one year, after the zoning issues have been decided. Note that both the costs and benefits of opening the playground are uncertain today, but will be certain in one year.
c. Based on your answers to (a) and (b), should you open the playground today, or should you wait until the zoning commission reaches its decision?