Exam question: Abandonment plus expansion option Sunny plc$,$ a firm in the leisure industry, is considering buying a plot of land to develop as a holiday park. The purchase price of the land is $$1\mathrm{.}8$ million. Sunny would need to spend an additional $$6$ million now to build the facilities for the site. The cash flows from this project will be either $$850,000$ every year $($probability $0\mathrm{.}7)$ or $$140,000$ every year $($probability $0\mathrm{.}3),$ in perpetuity, depending on whether the success of the holiday park is high or low, respectively. The first cash flow will occur in one year and at that time Sunny will know whether the parks success is high or low. Assume that $10\%$ is a suitable discount rate for all cash flows. Suppose that Sunny can sell the developed site, if it chooses to do so$,$ after one year, for $$6$ million. What is the expected value now of this abandonment option? Is the project worthwhile?Assume now that if the site is not sold, the firm can instead choose to extend it by investing a further $$1\mathrm{.}5$ million in one year. The cash flows from this expansion will be either $$30,000$ every year $($probability $0\mathrm{.}5)$ or $$400,000$ every year $($probability $0\mathrm{.}5)$ in perpetuity, depending on whether a competitor firm builds a site nearby. The first cash flow from the expansion will occur in two years. What is the expected value now of the expansion option?