Problem 3: A car company is considering building a new car. The investment for a 6-year project is $51 million If demand is good (30% probability), then the net cash flows will be $18 million per year for 6 years. If demand is bad (70% probability), then the net cash flows will be $8 million per year for 6 years. The firm's cost of capital is 10%. a/ What is the expected NPV of the project? b/ If the firm makes the investment today, then it may have the option to renew the project for 6 more years at year 6 for an additional payment of $51 million. In this case the cash flows that occurred previously will be repeated Write out the decision tree and use decision-tree analysis to calculate the expected NPV of this project, including the option to continue for an additional 6 years. Remember that the investment at year 6 is known, so it should be discounted at the risk-free rate, which is 2.97%. If the cost of having this option is $4 million, will you pay that amount of money to have that option? c/Would you take the same decision using the Black Scholes model to estimate the value of the option. Assume that the variance of the project's rate of return is 10% and that the risk-free rate is 2.97 Corp 341Exam2 Midterm2Y2020S3 Problem 3: A car company is considering building a new car. The investment for a 6-year project is $51 million If demand is good (30% probability), then the net cash flows will be $18 million per year for 6 years. If demand is bad (70% probability), then the net cash flows will be $8 million per year for 6 years. The firm's cost of capital is 10%. a/ What is the expected NPV of the project? b/ If the firm makes the investment today, then it may have the option to renew the project for 6 more years at year 6 for an additional payment of $51 million. In this case the cash flows that occurred previously will be repeated Write out the decision tree and use decision-tree analysis to calculate the expected NPV of this project, including the option to continue for an additional 6 years. Remember that the investment at year 6 is known, so it should be discounted at the risk-free rate, which is 2.97%. If the cost of having this option is $4 million, will you pay that amount of money to have that option? c/Would you take the same decision using the Black Scholes model to estimate the value of the option. Assume that the variance of the project's rate of return is 10% and that the risk-free rate is 2.97 Corp 341Exam2 Midterm2Y2020S3