X Mining has a lease, with two years remaining, in which it can extract nickel ore on a remote island in Indonesia. Over the two-year project life, the first year will be spent to develop the mining site and the second year to produce the nickel. The company has completed the exploration phase and estimates that the mine contains 5 million pounds of nickel ore that can be extracted. The ore contains 10% pure nickel.

X can contract with the only local mining company, C to develop the property over the first year at a cost of 0.8 million dollars and this development cost must be paid today. However, C has a busy schedule and requires this project to commence in year 0 rather than a later date. Once the site is developed, X can contract with a mine operator to extract the ore for a cash payment equal to 5 dollars per pound. The cost is paid at the end of the project life. Notably, nickel price is volatile; but X is confident that nickel price will stay in the range between 4 and 8 dollars per pound by end of the development year (at end of the first year) and throughout the second year. X requires a 15% rate of return for this two-year project. Risk-free interest rate is 5%.

1. What is the net present value (NPV) of the nickel lease project if the production is not sold in the forward market and XYZ Mining subjects itself to the uncertainties of the nickel market over the two-year project life? Assume the firm does not apply any real option at any time.
2. Explain how the company can use a real option to improve the lease projects valuation using the information provided in this question.