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:

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 .rm.s 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 project.s present value without the option to

scale down

(b) (5 points) Compute the project.s present value with the option to

scale down

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