QUE ST ION $14$

$1.$ ABC Inc. is evaluating an investment project that lasts for three years. The project has a cost

of capital of $10\%$ and requires an initial investment of $$3$ million. There is a $60\%$ chance that

the project would be successful and would generate annual free cash flows of $$2$ million per

year during the next three years. There is a $40\%$ chance that the project would be less

successful and would generate only $$1$ million per year during the next three years. However,

ABC recognizes that if the project is successful, it could invest $$2$ million at the end of the

second year to expand the project and receive a free cash flow of $$4$ million at the end of the

third year. ABC estimates that the net project value $($NPV$)$ of the project without the option to

expand and the NPV of the project with the option to expand would be closest to:

A The NPV of the project without the option to expand is $$0\mathrm{.}98$ million and the NPV of the

$.$ project with the option to expand is $$1\mathrm{.}79$ million

B The NPV of the project without the option to expand is $-$$$0\mathrm{.}51$ million and the NPV of

$.$ the project with the option to expand is $$1\mathrm{.}97$ million

C The NPV of the project without the option to expand is $$1\mathrm{.}97$ million and the NPV of the

$.$ project with the option to expand is $$3\mathrm{.}33$ million

D The NPV of the project without the option to expand is $-$$$0\mathrm{.}51$ million and the NPV of

$.$ the project with the option to expand is $$0\mathrm{.}81$million