Stanley Marcus, a financial intern at Mega Manufacturing Company (MMC), was asked by the CFO to review the NPV calculations on a major new product investment. After analyzing the cash flows and other calculations, Stanley confirmed that the NPV was $1.5 million. In the process of investigating all aspects of the project and its cash flows, Stanley learned that should the new product be successful, it would open the door to a number of opportunities to further expand the firm’s product line. Using option valuation techniques that he learned in an advanced finance course, he estimated the value of these expansion options to be $0.45 million.
a. Based on Stanley’s analysis, what is the value of the proposed new product investment?
b. How can Stanley explain the value found in part (a) to the CFO, who is unfamiliar with the concept of real options?