Your firm is thinking of expanding. The cost of expanding is $120 million. If you invest today, the expansion will generate free cash flows (FCF) of $3 million at the end of the year. After the first year, the expansion will produce profits of either $10 million at the end of every year in perpetuity (if the economy improves) or $5 million per year in perpetuity (if the economy does not improve). If you wait until next year to invest, you will lose the opportunity to make $3 million in FCF, but you will know the profits of the investment in the following year (that is, in a year from now, you will know what the investment continuation value will be in the following year). Suppose the risk-free rate is 5%, and the risk-neutral probability that the economy improves is 35%. Assume the cost of expanding is the same this year or next year.

QUESTION 18

Given the information above, the NPV of investing today is around:

a. $39.05 million b. $27.62 million c. $11.43 million d. None of the above

QUESTION 19

Given the above information, the NPV of waiting, i.e., investing one year from now, is around:

a. $80 million b. $12.38 million c. $26.67 million d. None of the above

QUESTION 20

The value of the option to wait is around:

a. $15 million b. $10 million c. $41 million d. -$10 million e. None of the above