Reliable Machinery Inc. is considering expanding its operations in Thailand. The initial analysis of the project yields the following results:

The project is expected to generate \($85\) million in after-tax cash flows every year for the next 10 years.

The initial investment in the project is expected to be \($750\) million.

The cost of capital for the project is 12%.

If the project generates much higher cash flows than anticipated, you will have the exclusive right for the next 10 years (from a manufacturing license) to expand operations into the rest of Southeast Asia. A current analysis suggests the following about the expansion opportunity:

The expansion will cost \($2\) billion (in current dollars). The expansion is expected to generate \($150\) million in after-tax cash flows each year for 15 years. There is substantial uncertainty about these cash flows, and the standard deviation in the present value is 40%.

The cost of capital for this investment is expected to be 12% as well. The risk-free rate is 6.5%.

a. Estimate the net present value of the initial investment.

b. Estimate the value of the expansion option.