Imagine it is 2015. You are the assistant to the Chief Financial Officer (CFO) of Phord Motor Company, an established manufacturer of conventional autos that is considering entering the self-driving car market with its Phord Model T1 self-driving car. Unfortunately, forecasts show that the T1 has a negative NPV of $36.52 million. The Ti's cash flows are shown in the table below. It can't meet the 18% hurdle rate. "The 11 just can't make it on financial grounds," the CFO says," but my gut instinct tells me we should go ahead." "But you're missing a very important financial advantage," you say to the CFO. "What?" says the CFO. "If we don't launch the T1," you say," it will probably be too expensive to enter the self-driving car market later when Tesla is firmly established. If we go ahead, we have the opportunity to make follow- on investments which could be extremely profitable. The T1 gives not only its own cash flows, but also a call option to go on with version 12 of the self-driving car." 2016 120 2017 140 2018 300 2019 700 Cash flows for Model T1 (in millions) 2015 After tax cash flows -150 Required Capital Investment -400 Increase in Working Capital -350 Net cash flows -900 0 0 -80 40 2020 0 0 175 175 0 100 400 -50 90 0 150 850 NPV @ 18% = -$36.52 million Question: Calculate a) the value of the option to invest in version 12 of the self-driving car; and b) the strategic (expanded) NPV of the T1. Assume: 1.) The decision to invest in the T2 must be made after 4 years, in 2019. 2.) The investment required for T2 is $990 million 3.) The present value of cash inflows for version T2 is $670 million 4.) The future value of version T2's cash flows is highly uncertain, with a standard deviation of 40% per year. 5.) The risk free rate is 5%