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 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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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

Solutions

Chapter
Section
Chapter 13, Problem 1P
Textbook Problem

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%.

  1. a. If the company does not consider real options, what is Project X’s expected NPV?
  2. b. What Is X’s expected NPV with the growth option?
  3. c. What is the value of the growth option?

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