Phord is considering entering the self driving car market with their T1 model car.

Forecasts show that the T1 has a negative NPV of $36.52 million. The T1's cash flows are shown in the table below. It can't meet the 18% hurdle rate.

The T1 gives not only its own cash flows, but also a call option to go on with version T2 of the self-driving car.

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 (amount they'll get in the future)

4.) The future value of version T2's cash flows is highly uncertain, with a standard deviation of 40% per year.

Cash flows for Model T1 (in millions)

2015

2016

2017

2018

2019

2020

After tax cash flows

-150

120

140

300

700

0

Required Capital Investment

-400

0

0

0

0

0

Increase in Working Capital

-350

-80

-50

100

150

175

Net cash flows

-900

40

90

400

850

175

NPV @ 18% = -$36.52 million

QUESTION:

Calculate:

a) the value of the option to invest in version T2 of the self-driving car; and

b) the strategic (expanded) NPV of the T1.