Question

Singh Development Co. is deciding whether to proceed with Project X. The cost would be $12 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 $13 million at the end of Year 2. Project Y would then be sold to another company at a price of $26 million at the end of Year 3. Singh’s WACC is 9%.

1. If the company does not consider real options, what is Project X’s expected NPV? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to three decimal places.
   $   million
2. 
   
3. What is X’s expected NPV with the growth option? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to three decimal places.
   $   million
4. 
   
5. What is the value of the growth option? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to three decimal places.
   $   million

Answer 1

Given,

Initial cost = $ 12 million

WACC = 9% or 0.09

Solution :-