. Maytag Inc. can invest in a new DRAM chip factory for $425 million. The factory, which must be invested in today, has cash ows two years from now that depend on the state of the economy. The cash ows when the factory is running at full capacity are described by the following tree diagram: 1 In year 1, Maytag Inc. has the option of running the plant at less than full capacity. In this case, workers are laid o, production of memory chips is scaled down, and the subsequent cash ows are half of what they would be when the plant is running at full capacity. An alternative use for rms funds is investment in the market portfolio. In the states that correspond to the branches of the tree above, $1 invested in the market portfolio grows as follows: Assume that the risk-free rate is 5 percent per year.

(a) (5 points) Compute the projects present value without the option to scale down

(b) (5 points) Compute the projects present value with the option to scale down

(c)(5 points) What is the value of the option to scale down?

year 0 veari year 2 Very good $1 billion Good Medium $200 million Bad Very bad 500 million In year 1, Maytag Inc. has the option of running the plant at less than full capacity. In this case, workers are laid off, production of memory chips is scaled down, and the subsequent cash flows are half of what they would be when the plant is running at full capacity. An alternative use for firm's funds is investment in the market portfolio. In the states that correspond to the branches of the tree above, si invest in the market portfolio grows as follows: year 0 year1 year 2 $1.20 $1.10 $1 $1.05 $0.95 S0.90