question 1-7-

Purplelimited plans to open a new shop in Melbourne. Purplelimited must open the new shop either now or in exactly one year.

If Purplelimited opens the shop now, it will cost Purplelimited $2.6 million immediately to open the new shop. Purplelimited expects to receive an annual cash flow of $240000 in perpetuity. The manager has the option to close the shop at the end of the first year and sell the shop for $5.28 million.

If Purplelimited opens the shop in one year, the probability of market demand being high and low is 57% and 43%, respectively. If the market demand is high, Purplelimited will spend $1 million to open the new shop, and expect to receive an annual cash flow of $340000 in perpetuity. If the market demand is low, Purplelimited will spend $0.5 million to open the new shop, and expect to receive an annual cash flow of $204000 perpetuity.

The cost of capital for this project is assumed to be 5%.

The NPV of this project for Purplelimited is closest to:

a.

$2.00 million

b.

$4.40 million

c.

$4.85 million

d.

$2.66 million