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A project requires an investment of $73 million and has expected annual cash flows of $21.88 million for 4 years, starting in one year. The
A project requires an investment of $73 million and has expected annual cash flows of $21.88 million for 4 years, starting in one year. The annual standard deviation of the project's returns is 40%.
The company can expand the project by investing another $73 million in 4 years and will then earn the same expected cash flows for another 4 years.
The appropriate discount rate for the project is 10% (EAR) and the risk-free rate is 4% (continuously compounded).
Question: What is the value of the option to expand (in $ million)?
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