Real Options - A Short Case

You have an opportunity to invest in a new car manufacturing plant for $5M.

Expectations as of today:

Annual cash flow in year 1: $600,000

Perpetual growth rate: 2% per year

Cost of capital: 12%

Risk-Free rate: 5%

A publicly traded car manufacturer exists. This firm is a perfect comparable for the investment

and has a return volatility = 40%

You have the possibility to invest today, or delay by exactly one year.

(a) What is the NPV of the project if you invest today?

(b) What is the NPV of the project if you wait for one year? Please use the Black Scholes

Model. (You may use Excel).

(c) Real investment decisions always come with the option to wait. Please elaborate (at

least a one-page write-up) on some pros and cons of delaying investment decision.