It is the beginning of year 0. Your firm has the opportunity to invest in a project. The project requires an initial development cost of $48 million at year 0. If the economic condition is good at year 1, the project will be worth $80 million. If the economic condition is not good, the project will be worth $20 million. The economic condition will be good with a risk-neutral probability of 50%. The risk free interest rate is 5%.

C. Suppose that the abandonment option in part B does not exist. Instead, assume that at year 1 you can double the production capacity of the project by investing an additional $40 million. If the economy turns out to be good and you double the production capacity, the project will be worth $165 million. If the economy turns out to be bad and you choose to double the production capacity, the project will be worth $50 million.

If the economic condition turns out to be good, should you double the production capacity?

If the economic condition turns out to be bad, should you double the production capacity?

What is the value of the project with the growth option?

What is the value of the option to double the production capacity of the project?