The Galactic Empire (a tax-free entity) is designing a mega-project with extraordinary economic potential. The “Star” project is expected to cost $102.7 billion over 5 years of construction (schedule of costs below, all occur at the end of each year) but it will provide a net reduction in operating expenses by $16.4 billion annually on a permanent basis (forever) starting at the end of year 5. The appropriate cost of capital for this project is just 4.3%.
What is the project’s NPV?
Some designers believe that the project could begin to provide benefits as early as the end of year 3. They would need to increase expenses in the first 3 years (time 0-2) by $3 billion annually and try some experimental technology but there is an 85% these investments would result in savings of $10 and 14 billion at the end of years 3 and 4 respectively. This new design would have a slightly higher operating cost however (whether it starts up early or not), reducing subsequent savings (year 6 onwards) to $16.3 billion annually.
Should the experimental design be incorporated in the project?
At the meeting, one engineer points out that the new design introduces a critical weakness which could be sabotaged by “troublemakers”, resulting in the immediate loss of all project assets. Although the probability of being able to exploit this vulnerability is very low (0.0000001% chance, once, at the end of year 2 after capex is spent), the engineer would like permission to spend an additional $450 installing a piece of sheet metal he says would negate this scenario entirely.
What is the NPV of this engineer’s suggestion?