Growth options

Activity Frame ten come across projects that have positive NPV opportunities in which the company does not invest. Companies must evaluate the valu

of the option to invest in a new project that would potentially contribute to the growth of the firm. These options are referred to as growth options.

Consider the case of Shoe Building Inc.:

Shoe Building Inc. is considering a three$-$year project that will require an initial investment of $$55,000.$ It has estimated that the annual

cash flows for the project under good conditions will be $$70,000$ and $$9,000$ under bad conditions. The firm believes that there is a $60\%$

chance of good conditions and a $40\%$ chance of bad conditions.

If the firm is using a weighted average cost of capital of $13\%,$ the expected net present value $($NPV$)$ of the project is

$($Note: Round

your answer to the nearest whole dollar.$)$

Shoe Building Inc. wants to take a potential growth option into account when calculating the project's expected NPV$.$ If conditions are good, the firm

will be able to invest $$3,000$ in year $2$ to generate an additional cash flow of $$23,000$ in year $3.$ If conditions are bad, the firm will not make any

further investments in the project.

Using the information from the preceding problem, the expected NPV of this project$-$when taking the growth option into account$-$is

$($Note: Round your answer to the nearest whole dollar.$)$