A company is considering investing in a project. If the market condition is good, the project...

 

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A company is considering investing in a project. If the market condition is good, the project payoff is 32,000, with probability 0.3. If the market condition is normal, the project payoff is 10,000, with probability 0.2. If the market condition is bad, the project payoff is 2,000 (the probability is 1 minus the sum of above two probabilities) The initial investment is 14,000. The firm needs to borrow money from a VC to finance this investment. After extensive research, the firm finds that if the market condition is good, the company could investment addition money 3,000 to expand operations, which would result in twice the original payoff. The VC provides the firm an option to borrow the additional investment if needed. How much is this expansion option worth? A company is considering investing in a project. If the market condition is good, the project payoff is 32,000, with probability 0.3. If the market condition is normal, the project payoff is 10,000, with probability 0.2. If the market condition is bad, the project payoff is 2,000 (the probability is 1 minus the sum of above two probabilities) The initial investment is 14,000. The firm needs to borrow money from a VC to finance this investment. After extensive research, the firm finds that if the market condition is good, the company could investment addition money 3,000 to expand operations, which would result in twice the original payoff. The VC provides the firm an option to borrow the additional investment if needed. How much is this expansion option worth?

Answer rating: 100% (QA)

SOLUTION To evaluate the expansion option we need to calculate the expected val... View the full answer