Vaughn Video is considering refurbishing its store at a cost of $1.4 million. Management is concerned about the economy and whether a competitor, Viola Video, will open a store in the neighborhood. Vaughn estimates that there is a 60% chance that Viola will open a store nearby next year. The state of the economy probably won't affect Vaughn until the second year of the plan. Management thinks there is a 40% chance of a strong economy and a 60% chance of a downturn in the second year. Assume Vaughn's cost of capital is 18%. Incremental cash flows are as follows:

Year 1: Viola opens a store - $700,000 Viola doesn't open a store - $900,000 Year 2: Viola opens a store, strong economy - $850,000 Viola opens a store, weak economy - $700,000 Viola doesn't open a store, strong economy - $1,500,000 Viola doesn't open a store, weak economy - $1,200,000

Vaughn Video has a real option possibility. Carlson Flooring has expressed an interest in trading buildings with Vaughn after Vaughn is refurbished. Carlson has offered to reimburse Vaughn for 70% of its refurbishment costs at the end of the first year if they make the trade. Vaughn would then forego all incremental cash flows for the second year. Carlson is willing to keep the option open for one year in return for a non-refundable payment of $150,000 now. Should Vaughn pay the $150,000 to keep the option available? Why?/Why not?