Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Consider an investment opportunity with an option to grow that requires a $10m investment today. In one year we will find out whether the project

Consider an investment opportunity with an option to grow that requires a $10m investment today. In one year we will find out whether the project is successful or not. The probability that the project will generate $1M per year in perpetuity (starting from one year after the investment is made; that is, starting from year 1) is 50%. Otherwise, the project will generate nothing. You can double the size of the project in year 1 if the original project is successful. Proceeding with the extension will require an additional $10m investment which will allow the firm to generate an incremental annual cash flow $1M in perpetuity starting from year 2 (that is, there is no uncertainty about future cash flows from the extended project). Assume the risk-adjusted discount rate is 6% p.a. and do not consider any other factors.

(a) What is the NPV of the project without growth option?

(b) What is the NPV of the project with growth option? (Hint: compute the PV of the growth option first by considering cash flows from the expanded project only)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

The Handbook Of Loan Syndications And Trading

Authors: Marsh, Lee Shaiman, Bridget Marsh

2nd Edition

1264258526, 978-1264258529

More Books

Students also viewed these Finance questions