Staged investment-the option to expand

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Reference no: EM13890723

[Staged Investment: The Option to Expand]

Consider an investment opportunity with an option to grow that requires a $10m investment today. In one year we will find out whether the project is successful or not. The probability that the project will generate $1M per year in perpetuity is 50%. Otherwise, the project will generate nothing. You can double the size of the project on the original terms in year 1 if the original project is successful. Assume the risk-adjusted discount rate is 6% p.a. and do not consider any other factors.

(a) What is the NPV of the project without growth option?

(b) What is the NPV of the project with growth option? (Hint: compute the PV of the growth option first by considering cash flows from the expanded project only)

Reference no: EM13890723

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