A company is considering investing in a project. The future perpetual cash flow is either $$750$K if the market goes up or $$125$K if the market goes down next year. The objective probability the market will go up is $20\%.$ The appropriate risk$-$adjusted rate of return $($cost of capital$)$ is $25\%.$ The initial capital investment required at time $0$ is $$1200$K$.$

 a$)$ Should the company invest in this project  ?

 

b$)$ Upon closer inspection the CFO realizes the company actually has some flexibility in managing this project. Specifically, if the market goes down, the company can abandon the project, and liquidate its original capital investment for $75\%$ of its original value. The CFO wants to know if the company should now proceed with the project with the added flexibilities, and ask for your advice.

Answer rating: 100% (QA)

a To determine if the company should invest in the project we calculate the expected cash flow Expec... View the full answer