Reference no: EM132104366

Question - Caravan Gaming Company is interested in developing a new facility in Brazil. The company estimates that the project would require an initial investment of $31 million. The company expects that the project will produce positive cash flows of $5,050,000 a year at the end of each of the next 15 years. The project's cost of capital is 14%.

a. Calculate the expected net present value of the project.

b. The company recognizes that the cash flows may be much higher or lower, depending on whether the host government imposes a large facility tax. One year from now, the company will know whether the tax will be imposed. There is a 45 percent chance that the tax will be imposed, in which case the yearly cash flows will be only $4.5 million for 15 years and there is a 55 percent chance that the tax will not be imposed, in which case the yearly cash flows will be $5.5 million for 15 years. If the company waits a year to start the project, the initial investment will remain at $31 million, and incoming cash flows will be delayed one year. Cost of capital remains the same. Calculate the value of the real option by waiting one year to decide. What would you recommend to the company?

c. Apart from real options, discuss 3 qualitative factors that the company should consider when making its decision on accepting the new project.