A project runs for two periods and then is sold at a fair price. Its present value without flexibility (i.e. real options) is 30 million, and the initial investment is 20 million. The annual volatility of the projects present value is expected to be 15% and its WACC is 12%. At the end of the second period there is an option to expand, increasing the value of the project by 20% by investing an additional 5 million. The risk-free rate is 5%.

a) What is the projects Net Present Value (NPV) without the option to expand?

b) What is the value of real option to expand the project?

c) Explain how various corporate liabilities can be interpreted as options