Companies often come across projects that have positive NPV opportunities in which the company does not invest. Companies must evaluate the value of the option to invest in a new project that would potentially contribute to the growth of the firm. These options are referred to as growth options. Markung's Co. is considering a three-year project that will require an initial investment of $30,000. It has estimated that the annual cash flows for the project under good conditions will be $60,000 and $11,000 under bad conditions. The firm believes that there is a 60% chance of good conditions and a 40% chance of bad conditions. If the firm is using a weighted average cost of capital of 13%, the expected net present value (NPV) of the project is round intermediate calculations and round your answer to the nearest dollar.) Markung's Co. wants to take a potential growth option into account when calculating the project's expected NPV. If conditions are good, the firm will be able to invest $6,000 in year 2 to generate an additional cash flow of $21,000 in year 3. If conditions are bad, the firm will not make any further investments in the project. Using the information from the preceding problem, the expected NPV of this project-when taking the growth option into account-is (Note: Do not round intermediate calculations and round your answer to the nearest dollar.) (Note: Do not Markung's Co.'s growth option is worth (Note: Do not round intermediate calculations and round your answer to the nearest dollar.)
Companies often come across projects that have positive NPV opportunities in which the company does not invest. Companies must evaluate the value of the option to invest in a new project that would potentially contribute to the growth of the firm. These options are referred to as growth options. Markung's Co. is considering a three-year project that will require an initial investment of $30,000. It has estimated that the annual cash flows for the project under good conditions will be $60,000 and $11,000 under bad conditions. The firm believes that there is a 60% chance of good conditions and a 40% chance of bad conditions. If the firm is using a weighted average cost of capital of 13%, the expected net present value (NPV) of the project is round intermediate calculations and round your answer to the nearest dollar.) Markung's Co. wants to take a potential growth option into account when calculating the project's expected NPV. If conditions are good, the firm will be able to invest $6,000 in year 2 to generate an additional cash flow of $21,000 in year 3. If conditions are bad, the firm will not make any further investments in the project. Using the information from the preceding problem, the expected NPV of this project-when taking the growth option into account-is (Note: Do not round intermediate calculations and round your answer to the nearest dollar.) (Note: Do not Markung's Co.'s growth option is worth (Note: Do not round intermediate calculations and round your answer to the nearest dollar.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
100%
Transcribed Image Text:### Evaluating Growth Options in Investment Projects
Companies often come across projects that have positive NPV (Net Present Value) opportunities in which the company does not invest. Companies must evaluate the value of the option to invest in a new project that would potentially contribute to the growth of the firm. These options are referred to as **growth options**.
---
**Project Analysis Example:**
Markung's Co. is considering a three-year project that will require an initial investment of $30,000. It has estimated that the annual cash flows for the project under good conditions will be $60,000 and $11,000 under bad conditions. The firm believes that there is a 60% chance of good conditions and a 40% chance of bad conditions.
---
**Expected NPV Calculation:**
If the firm is using a weighted average cost of capital of 13%, the expected net present value (NPV) of the project is __________.
*(Note: Do not round intermediate calculations and round your answer to the nearest dollar.)*
---
**Growth Option Consideration:**
Markung's Co. wants to take a potential growth option into account when calculating the project’s expected NPV. If conditions are good, the firm will be able to invest $6,000 in year 2 to generate an additional cash flow of $21,000 in year 3. If conditions are bad, the firm will not make any further investments in the project.
---
**Expected NPV with Growth Option:**
Using the information from the preceding problem, the expected NPV of this project—when taking the growth option into account—is __________.
*(Note: Do not round intermediate calculations and round your answer to the nearest dollar.)*
---
**Value of Growth Option:**
Markung’s Co.’s growth option is worth __________.
*(Note: Do not round intermediate calculations and round your answer to the nearest dollar.)*
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education