Global Logistics needs to rent space for storing product for the next three years. The following information regarding the demand and spot price is available. Current demand for the product is 150,000. Historically, Global Logistics has required 1500 square feet to store 1500 units of the product. Demand for the product can go up by 20% with a probability of 0.7 or down by 20% with a probability of 0.3. Global Logistics can sign a three-year fixed lease to rent 150,000 square feet of space at $1.00 per square foot per year. The firm may also choose to obtain warehousing space on the spot market. The current spot market price is $1.20 per square foot per year. The spot price can go up by 10% with a probability of 0.8 and can decrease by 10% with a probability of 0.2. The firm receives a revenue of $1.22 for each unit of demand.

a) Create a decision tree showing period 0, 1 and 2 for the scenario described above.

b) Calculate the NPV for the option when the firm decides to sign a three-year lease for 150,000 square feet of space and get additional requirements from the spot market.