In Section 8.3, option to expand, let the cost to expand be $1M, which results in estimated net positive cash flows in the following 5 years of

$0.22M each year. Use an interest rate of 5% per annum.

For the deterministic calculations, what is the present worth of the cash flows? Is the expansion viable according to deterministic thinking?

Consider the probabilistic calculations for this example. Let the estimated pessimistic and optimistic values for the cash flows be

±50% of the mean. Assume perfect correlation between the net positive cash flows. Calculate Var[PW], Φ, mean of PW upside and the option value OV.

Does the option value convert a nonviable investment into a viable one?