This question is a variant of the Sport Hotel example that was presented in class, in the class notes, and in the Real Option chapter. The original problem stated that in the first year, costs would total $1m. In Year 2, costs would be $2m. In year 3, costs would be $2m for a total of $5m. The change to consider is this: suppose that the value of the hotel is one of two values: $9.5 million if the city is successful in obtaining the franchise (and not $8 million as in the original problem) or $3.3 if the city is not successful in obtaining the franchise (and not $2 million as in the original problem).

All other aspects of the problem are the same as originally presented, such as the costs per year. Assume that the probability of obtaining the franchise is 50%. Incorporating these new hotel values from above, and the real option, what is the new NPV of the project?

$1.75m

$1.4m

$4.5m

$2.25m