Singh Development Co. is deciding whether to proceed with Project X.The cost would be $11 million in Year 0. There is a 50% chance that X would be hugelysuccessful and would generate annual after-tax cash flows of $7 million per year duringYears 1, 2, and 3. However, there is a 50% chance that X would be less successful and wouldgenerate only $1 million per year for the 3 years. If Project X is hugely successful, it wouldopen the door to another investment, Project Y, which would require an outlay of $8 millionat the end of Year 2. Project Y would then be sold to another company at a price of$16 million 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?
Singh Development Co. is deciding whether to proceed with Project X.
The cost would be $11 million in Year 0. 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 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 outlay of $8 million
at the end of Year 2. Project Y would then be sold to another company at a price of
$16 million 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
b. What is X’s expected NPV with the growth option?
c. What is the value of the growth option?
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