Growth Option

Martin Development Co. is deciding whether to proceed with Project X. The cost would be $7 million in Year 0. There is a 50% chance that X would be hugely successful and would generate annual after-tax cash flows of $5 million per year during Years 1, 2, and 3. However, there is a 50% chance that X would be less successful and would generate only $1 million per year for the 3 years. If Project X is hugely successful, it would open the door to another investment, Project Y, which would require an outlay of $10 million at the end of Year 2. Project Y would then be sold to another company at a price of $20 million at the end of Year 3. Martins WACC is 8%.

If the company does not consider real options, what is Project Xs expected NPV? NPV = $ million (to 3 decimals).

What is Xs expected NPV with the growth option? NPV = $ million (to 3 decimals).

What is the value of the growth option? $ million (to 3 decimals).