The assignment is to evaluate both parts, the traditional NPV calculation as well as the Real Options approach.

Scenario: A company must decide whether to invest $100 million in developing and implementing a new enterprise system in the face of considerable technological and market (demand for product and market share) uncertainty. The firm's cost of capital is 10%.

Part 1.

The probability of a successful project (or pilot) is now .7 and the probability of an unsuccessful project is .3.

Good Result: The Free Cash flow perpetuity (Annual Benefits) in the good case is $15 million per year

Bad Result: The system proves to be more difficult to implement and improvements in management of the supply chain are less. In addition, the growth in market demand for the product is lower. The Free Cash flow perpetuity (Annual Benefits) in the "bad" case is now $1.5 million per year, not $2 million.

Given: Year 0 (now) cash flows: $-100 million for ERP purchase and implementation.

The cost of capital is .1. Use this to calculate the PV of the good perpetuity and the PV of the bad perpetuity. Then calculate the good NPV and the bad NPV. Finally calculate the Expected NPV and decide if you will invest.