We have an opportunity to invest in a two-stage project. Stage one involves investing $5 million today to start-up and provides cash flows of $1 million over each of the next three years. The discount rate to the project is 21%. Annual risk free interest is 5%, while the volatility of the project returns is estimated at 200% per year.

If we receive good information over the first two years, we will have an option to invest an additional $10 million in stage 2 (which is exactly 2 years from today). Based on today’s information, the incremental project has a present value in year 2 equal to $15 Million. Volatility of the incremental investment is the same as the overall project. Is this a good opportunity for us? Show all work

Answer rating: 100% (QA)

Year Cash Flow PV 21 DCF 1 1000000 08264 ... View the full answer