Chapter 10, Problem 25PS

Real options An auto plant that costs $100 million to build can produce a line of flex-fuel cars. The investment will produce cash flows with a present value of $140 million if the line is successful but only $50 million if it is unsuccessful. You believe that the probability of success is only about 50%. You will learn whether the line is successful immediately after building the plant.

1. a. Would you build the plant?
2. b. Suppose that the plant can be sold for $95 million to another automaker if the auto line is not successful. Now would you build the plant?
3. c. Illustrate the option to abandon in part (b) using a decision tree.