You have recently been employed as a finance consultant to a growing company, R&D Industries, which consistently develops successful products. After a meeting with the company’s management, you estimate that the company produces, on average, two new product proposals every three years. The company’s management informs you that the investment opportunities the company produces typically have an initial investment requirement of £10 million, and return annual cash flows of £1 million in perpetuity. After conducting a scenario analysis, you estimate that these cash flows could grow at one of three possible rates, which have an equal probability of occurring: -3%, 0%, and 3%. The company’s management tell you that the projects are ‘take it or leave it’

opportunities. In other words, the company does not have the option to wait to invest under more favourable circumstances.

(a) If the company’s cost of capital is 12 per cent, what is the present value of the company’s future growth opportunities under each scenario?

(b) Which projects would be accepted or rejected?