Reference no: EM132162844

Assignment -

Make sure to show the excel calculations and formulas.

This is to evaluate the real options approach and allows for flexibility and the delay of the investment for 1 year. The cost of the project will rise to $110 Million ($10 Million

This year and $100 Million next year) with the one-year delay and additionally management decides to purchase and implement the financial module in year 1 at a cost of $10 Million (real option).

The results are slightly different:

Year 0 (now) cash flows: $10 million for the pilot project.

After year 1, if the conditions indicate a good result, the firm will invest the $100 million for the ERP with expected benefits (cash flows) of $15 million annually (forever) beginning in year 2. Benefits in year 1 from the financial module are $1 million.

If a bad result is indicated, the firm makes no further investments beyond the financial module, which yield annual benefits of $.5 million in year 1 and each year thereafter (forever).

Here the firm has flexibility and has exercised its option to make no further investments based on better information and knowledge of expected future benefits. In addition, consider that we have the opportunity to do a pilot program by installing the financial model only at a cost of $10 MM. A year from now, we can decide whether to invest in the full plant or not. Obviously, we won't exercise the option if we discover that we're in the Bad Case. So, we limit our loss to $10 MM less the present value of the bad case starting in Year 1.

Using the above information, make sure to show the excel calculations and formulas to:

1. Evaluate the expected NPV of this project using the described real option.

2. Show the excel calculation and formula of good case of NPV.

3. Show the excel calculation and formula of bad case of NPV.

4. Show the excel calculation and formula of expected NPV.