Huntsman Chemical is a relatively small chemical company located in Port Arthur, Texas. The firm’s management is contemplating its first international investment, which involves the construction of a petrochemical plant in São Paulo, Brazil. The proposed plant will have the capacity to produce 100,000 tons of the plastic pellets that are used to manufacture soft drink bottles. In addition, the plant can be converted to produce the pellets used in the manufacture of opaque plastic containers such as milk containers.
The initial plant will cost $ 50 million to build, but its capacity can later be doubled at a cost of $ 30 million should the economics warrant it. The plant can be financed with a $ 40 million nonrecourse loan provided by a consortium of banks and guaranteed by the Export Import Bank. Huntsman’s management is enthusiastic about the project be-cause its analysts think that the Brazilian economy is likely to grow into the foreseeable future. This growth, in turn, may offer Huntsman Chemical many additional opportunities in the future as the company becomes better known in the region.
Based on a traditional discounted cash flow analysis, Huntsman’s analysts estimate that the project has a modest NPV of about $ 5 million. However, when Huntsman’s executive committee members review the proposal, they express concern about the risk of the venture, based primarily on their view that the Brazilian economy is very uncertain. Toward the close of their deliberations, the company CEO turns to the senior financial analyst and asks him whether he has considered something the CEO has recently read about called real options in performing his discounted cash flow estimate of the project’s NPV.
Assume the role of the senior analyst and provide the CEO with a brief discussion of the various options that may be embedded in this project. Sketch very roughly how these options can add to the value of the project. (No computations are required.)