The ABC firm is considering an investment in a new production facility. For the next five years, the company expects to achieve an annual operating cash flow of $3.5M if the project is successful and $1.0M if the project is a failure. Projects of this nature are successful 60% of the time. The initial investment required is $9.5M and the relevant discount rate is 10%. Assume the production facility will be obsolete five years from now.

a) What is the base case NPV?

= -23,033 REJECT

b) Suppose the company has an option to double the scale of the project in one year if the project is a success at the end of the first year. This would imply that, if the project is successful, project annual cash flows would be $7.0M after expansion. What is the NPV with the expansion?

= 6,028,528 ACCEPT

c) What is the value of the option to expand?

=6,051,561