Assume that you work for the Otis Elevator in their procurement and supply-chain division. Seven years ago, Otis developed (being fictional here.) a new elevator called the Gravity Assist (GA) model. You are responsible for sourcing a component part for the GA Elevator from ABC Engineering under a contract that started 7 years ago, when the GA was first created. Consider the real options involved in your contract with ABC:

1. The ability to extend, if Otis desires, for an additional 3 years (years 8,9 and 10).
2. The ability to buy a fixed quantity at a fixed price for each year (whether in the first 7 years, or now if you continue into years 8,9 and 10). If Otis specifies the exact quantity, ABC is more efficient in their manufacturing, and will sell that exact quantity at $9,300 per unit. Otherwise, if a variable quantity is demanded during the year, Otis pays $10,000 per unit for whatever quantity it buys from ABC that year.

In theory, a firm has one WACC for everything it does but as mentioned, firms often take a short-cut in pricing various riskiness of different projects by using different WACCs for those projects to compensate for the different risks of the various projects. Assume that this is what Otis is doing. When the GA (and this contract) started 7 years ago, the GA project (within Otis, not for ABC) had a WACC of 13% (based upon firms cost of capital and the risk of this specific project). The overall WACC for Otis was 11% (since other projects of the firm were less risky). Otis still has the same overall WACC of 11%, but you now think that the GA has (for your firm, not for ABC) an even higher WACC of 15% since competitors have jumped into the field and the cash flows may be more volatile (riskier).

QUESTION: It is the last day of Year #7. Based upon what the changed WACC is telling you about this specific (GA) line of business, is that line of business more or less attractive going forward? Is the optionality of the contract (ability to choose the three-year extension with ABC) more or less valuable now, as compared to when you first wrote the contract? How about the optionality of choosing fixed quantities versus variable quantities? The reason for your answers??