How valuable is the growth option

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Nishi Trading Ltd is deciding whether to proceed with Project X. The cost would be $9 million in Year 0. There is a 50% chance that X would be hugely successful and would generate annual after-tax cash flows of $6 million per year during Years 1, 2, and 3. However, there is a 50% chance that X would be less successful and would generate only $1 million per year for the 3 years. If Project Xis hugely successful, it would open the door to another investment, Project Y, which would require an outlay of $10 million at the end of Year 2. Project Y would then be sold to another company at a price of $20 million at the end ofYear 3. Nishi Trading Ltd WACC is 11%.

Problem (a) If the company does not consider real options, what is Project X's NPV?

Problem (b) What is Project X's NPV considering the growth option?

Problem (c) How valuable is the growth option?

Reference no: EM132938137

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