15% Recession The present value of future cash flows in each state for both plant configurations...

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15% Recession The present value of future cash flows in each state for both plant configurations are modeled as follows: Recession State Exceptional Average Slow Recession PV Large Scale $2.38 $1.88 $1.38 $500M NOTE, the amounts in the above table are ALREADY discounted. For example, in the exceptional state, the NPV of the large-scale plant is the present value of future cash flows less the initial investment, or $2.3B - 1.5B = $800M. Average Slow Recession Question 1: Given the above facts, should the company open a large or small-scale operation? Small Scale $800M $800M $750M $600M Question 2: The company has developed a prototype of a "flexible" plant. The basic configuration is the same as the small-scale plant with the advantage that after a year of operations, the company can expand the plant. This expansion will not bring it to "large-scale" operations, but will allow the company to expand if need be. The initial investment in the flexible plant will be higher than the small scale, costing $950M. The present value of future cash flows in each state for both original plant configurations and the new flexible configuration are modeled as follows: Large Scale State Exceptional $2.3B $1.8B $1.3B $500M Small Scale $800M $800M $750M $600M Flexible - DON'T Expand $750M $750M $700M $550M Flexible - Expand $1.8B $1.4B $690M $600M Given the above facts, should the company open a large or small-scale operation, or the new flexible configuration? What is the value of the "option to expand" in the flexible case? 15% Recession The present value of future cash flows in each state for both plant configurations are modeled as follows: Recession State Exceptional Average Slow Recession PV Large Scale $2.38 $1.88 $1.38 $500M NOTE, the amounts in the above table are ALREADY discounted. For example, in the exceptional state, the NPV of the large-scale plant is the present value of future cash flows less the initial investment, or $2.3B - 1.5B = $800M. Average Slow Recession Question 1: Given the above facts, should the company open a large or small-scale operation? Small Scale $800M $800M $750M $600M Question 2: The company has developed a prototype of a "flexible" plant. The basic configuration is the same as the small-scale plant with the advantage that after a year of operations, the company can expand the plant. This expansion will not bring it to "large-scale" operations, but will allow the company to expand if need be. The initial investment in the flexible plant will be higher than the small scale, costing $950M. The present value of future cash flows in each state for both original plant configurations and the new flexible configuration are modeled as follows: Large Scale State Exceptional $2.3B $1.8B $1.3B $500M Small Scale $800M $800M $750M $600M Flexible - DON'T Expand $750M $750M $700M $550M Flexible - Expand $1.8B $1.4B $690M $600M Given the above facts, should the company open a large or small-scale operation, or the new flexible configuration? What is the value of the "option to expand" in the flexible case?

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Answer 1 In the exceptional state the net present value NPV of the largescale plant is 800M and the NPV of the smallscale plant is 800M In the average ... View the full answer