Reference no: EM132566386

The Panhandle Corporation is considering whether to go ahead with a small-scale trial project that requires an initial outlay of $900,000 and, if successful produce cash inflows of $450,000 in year one followed by $540,000 per year in perpetuity starting at the end of year two. If not successful, the project will produce no cash flows. The probability of success is 38%. Given the extreme riskiness of this project the company decides to use 28% as a risk-adjusted discount rate for this project.

-Given the above information and based on static analysis, should the company go ahead with its investment?

-Upon further study the company realizes that, if the project was successful, it creates an opportunity to expand production by investing an additional $9 million at the end of year one. The new investment would increase the project cash flows to $2.20 million (instead of $540,000) per year in perpetuity. Also, at that point the company feels that a major part of the risk associated with the project would have been resolved and that from year one on it can use its WACC of 15%. Given this information, should the company go ahead with the investment?

-What is the present value of the option to expand?