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Question 7. (10 marks) Alpha Co (Alpha) is considering building a factory either in Chile or Iceland. Alpha cannot build in both Chile and Iceland and needs to choose. If Alpha builds the factory in Iceland, it will cost $5 million immediately, and $3 million each in year 1 and year 2 , respectively. The factory will take 4 years to build. If there is high demand for the factory built in Iceland, it will generate $8 million per year in perpetuity. If there is low demand for the factory built in Iceland, it will generate $1 million per year in perpetuity. The probability that there will be high demand for the factory built in Iceland is 25% and the probability that there will be low demand for the factory built in Iceland is 75%. If Alpha builds the factory in Chile, it will cost $2 million immediately, $3 million in year 1 , and will take 2 years to build. If the factory is built in Chile it is expected to generate $3 million per year in perpetuity. The required rate of return for Alpha is 10%. Assume cash flows occur at the end of each year, except for initial cash flows, which occur immediately. (a) Should Alpha build the factory in Chile or in Iceland? Explain. Answer based only on the information provided. (Show all your work. Your answer must be handwritten.) (5 marks) (b) Iceland is looking to attract investments and offers Alpha an option to sell the factory to the government of Iceland at a price of $20 million, 6 years after the initial investment. If Alpha chooses the option to sell the factory to the government, it will not receive the cash flows generated from the factory in that year. Should Alpha choose to build the factory in Chile or in Iceland, after considering the option? Answer based only on the information provided. (Show all your work. Your answer must be handwritten.) (5 marks) Question 7. (10 marks) Alpha Co (Alpha) is considering building a factory either in Chile or Iceland. Alpha cannot build in both Chile and Iceland and needs to choose. If Alpha builds the factory in Iceland, it will cost $5 million immediately, and $3 million each in year 1 and year 2 , respectively. The factory will take 4 years to build. If there is high demand for the factory built in Iceland, it will generate $8 million per year in perpetuity. If there is low demand for the factory built in Iceland, it will generate $1 million per year in perpetuity. The probability that there will be high demand for the factory built in Iceland is 25% and the probability that there will be low demand for the factory built in Iceland is 75%. If Alpha builds the factory in Chile, it will cost $2 million immediately, $3 million in year 1 , and will take 2 years to build. If the factory is built in Chile it is expected to generate $3 million per year in perpetuity. The required rate of return for Alpha is 10%. Assume cash flows occur at the end of each year, except for initial cash flows, which occur immediately. (a) Should Alpha build the factory in Chile or in Iceland? Explain. Answer based only on the information provided. (Show all your work. Your answer must be handwritten.) (5 marks) (b) Iceland is looking to attract investments and offers Alpha an option to sell the factory to the government of Iceland at a price of $20 million, 6 years after the initial investment. If Alpha chooses the option to sell the factory to the government, it will not receive the cash flows generated from the factory in that year. Should Alpha choose to build the factory in Chile or in Iceland, after considering the option? Answer based only on the information provided. (Show all your work. Your answer must be handwritten.)
