East Texas Energy Inc (ETE) is considering a investing in a new oil reserve. The project will cost $71 million up front and is expected to generate cash flows during each of the following three years, with the amount of cash flow directly related to oil prices. ETEs finance department has forecast three likely scenarios for oil prices. There is a 10% probability that oil prices will increase, with associated FCF of $40 million per year for three years. There is a 80% probability that oil prices will remain near current levels, with associated FCF of $30 million per year for three years. The third possibility is a 10% probability that oil prices will decline, with associated FCF of $20 million per year for three years. ETE has determined that the required rate of return for this project is 15%.

If ETE invests in the new oil reserve, then the investment will also contain an option to expand or grow. This growth option will allow ETE opportunity to replicate the project at the end of the projects original life, with the same cost, FCF, and years of FCF.

2. Compute the expected NPV of the new oil reserve with the growth option.

3. Compute the value of the Growth Option.

4. Should ETE accept or reject the project?