Use the following information to answer questions 5-6. You are considering opening a CPA practice. Getting a practice started is simple, but only a few CPAs see significant growth in their client base. You think there is a 20% chance that you will end up with an extremely successful practice. You expect start-up costs in year zero (i.e., an office building, hiring expenses, initial marketing, etc.) of $350,000. If you do end up with a very successful practice, you expect annual free cash flow of $55,000 in perpetuity. However, if your practice is only of average success, you expect annual free cash flow of $25,000 in perpetuity. You can finance the firm with a 10% cost of capital.

What is the NPV of this potential investment (if calculated as we would do in Finance 325)?

Now assume that, if your firm turns out to be extremely successful (you will know by the end of the first year), you will be able to expand services to include financial advising. You expect advising services to have essentially no start-up costs and to provide you with $25,000 in additional free cash flow. What is the NPV if you include the value of this real option to expand?