2. Growth options

Companies often come across projects that have positive NPV opportunities in which the company does not invest. Companies must evaluate the value of the option to invest in a new project that would potentially contribute to the growth of the firm. These options are referred to as growth options.

Consider the case of Shoe Building Inc.:

Shoe Building Inc. is considering a three-year project that will require an initial investment of $35,000. It has estimated that the annual cash flows for the project under good conditions will be $40,000 and $9,000 under bad conditions. The firm believes that there is a 60% chance of good conditions and a 40% chance of bad conditions.

If the firm is using a weighted average cost of capital of 13%, the expected net present value (NPV) of the project is . (Note: Round your answer to the nearest whole dollar.)

Shoe Building Inc. wants to take a potential growth option into account when calculating the projects expected NPV. If conditions are good, the firm will be able to invest $3,000 in year 2 to generate an additional cash flow of $23,000 in year 3. If conditions are bad, the firm will not make any further investments in the project.

Using the information from the preceding problem, the expected NPV of this projectwhen taking the growth option into accountis . (Note: Round your answer to the nearest whole dollar.)

Shoe Building Inc.s growth option is worth . (Note: Round your answer to the nearest whole dollar.)