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
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Transcribed Image Text:3. Singh Development Co. is deciding whether to proceed with Project X. The after-tax cost would be $11
million in Year O. There is a 50% chance that X would be hugely successful and would generate annual after-
tax cash flows of $7 million per year during Years 1, 2, and 3. However, there is a 50% chance that X would be
less successful and would generate after-tax cash flows of only $1 million per year for the 3 years. If Project X
is hugely successful, it would open the door to another investment, Project Y, which would require an after-tax
outlay of $8 million at the end of Year 2. Project Y would then be sold to another company netting $16 million
after taxes at the end of Year 3. Singh's WACC is 9%.
a. If the company does not consider real options, what is Project X's expected NPV?
b. What is X's expected NPV with the growth option?
c. What is the value of the growth option?
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