The NPV of a new video game, Petty Larceny 1, is -$2M after discounting all expected cash flows. However, if high demand in the market evolves, Petty Larceny 2 is a possible follow-on opportunity in two years. In Year 2 it will cost $12M to start Petty Larceny 2, which will produce a one-time cash flow of $16M in year 3. The firm's cost of capital is 12% and the risk-free rate is 4%. Estimated volatility for the project is 35%. What is the Petty Larceny 1 NPV with the follow-on investment option? ○ -$1.35 M ○ $0.00 M ○ $0.35 M ○ $2.65 M
The NPV of a new video game, Petty Larceny 1, is -$2M after discounting all expected cash flows. However, if high demand in the market evolves, Petty Larceny 2 is a possible follow-on opportunity in two years. In Year 2 it will cost $12M to start Petty Larceny 2, which will produce a one-time cash flow of $16M in year 3. The firm's cost of capital is 12% and the risk-free rate is 4%. Estimated volatility for the project is 35%. What is the Petty Larceny 1 NPV with the follow-on investment option? ○ -$1.35 M ○ $0.00 M ○ $0.35 M ○ $2.65 M
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter14: Real Options
Section: Chapter Questions
Problem 4MC
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![The NPV of a new video game, Petty Larceny 1, is -$2M after discounting all expected cash
flows. However, if high demand in the market evolves, Petty Larceny 2 is a possible follow-on
opportunity in two years. In Year 2 it will cost $12M to start Petty Larceny 2, which will
produce a one-time cash flow of $16M in year 3. The firm's cost of capital is 12% and the
risk-free rate is 4%. Estimated volatility for the project is 35%. What is the Petty Larceny 1
NPV with the follow-on investment option?
○ -$1.35 M
○ $0.00 M
○ $0.35 M
○ $2.65 M](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fde23f7f8-907b-4cc4-994b-340fe0cb5c9d%2F22532d1e-40ba-4bfb-b699-40cedaf520e4%2Fk0fq0k_processed.png&w=3840&q=75)
Transcribed Image Text:The NPV of a new video game, Petty Larceny 1, is -$2M after discounting all expected cash
flows. However, if high demand in the market evolves, Petty Larceny 2 is a possible follow-on
opportunity in two years. In Year 2 it will cost $12M to start Petty Larceny 2, which will
produce a one-time cash flow of $16M in year 3. The firm's cost of capital is 12% and the
risk-free rate is 4%. Estimated volatility for the project is 35%. What is the Petty Larceny 1
NPV with the follow-on investment option?
○ -$1.35 M
○ $0.00 M
○ $0.35 M
○ $2.65 M
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