Question

Iridium Corp. has spent $ 3.2 billion over the past decade developing a​ satellite-based telecommunication system. It is currently trying to decide whether to spend an additional $ 352 million on the project. The firm expects that this outlay will finish the project and will generate cash flow of $ 15.1 million per year over the next 5 years. A competitor has offered $ 460 million for the satellites already in orbit. Classify the​ firm's outlays as sunk costs or opportunity costs​, and specify the incremental cash flows.

Answer 1

1. Sunk costs : $3.2 billion is a sunk cost as it is already incurred.

2. Opportunity costs: $352 million investment for finishing project is an Opportunity cost. However it will yield $15.1 million per annum for next 5 Yrs.

So Present Value of this CF is less than $15.1
`*` 5=$75.5 million.

So Net Present Value = CF0 + CF1 + ......+ CF5 = -352 + Less than 75 = Negative.

So another Opportunity of selling the Satellite for $460 million is a better option.

3. Specify the relevant cash flows.

If additional $352 million investment is undertaken,

$352 million will be Cash outflow in Y(0). It will result in Annual CF of $15.1 million for next 5 yrs.