Hightech Plc is considering whether or not to go ahead with the production of an innovative product. The project (called Project A) requires an initial investment (at time 0) of 10 million, while the company expects the future cash flows to depend on market demand. If demand is high, starting from next year (time 1) the project will produce a perpetual cash flow of 800,000. In case of low demand, the perpetual cash flow will amount to just 300,000. The two scenarios of high and low demand are equally likely (50% probability for each scenario). The projects cost of capital is 8%. Should Hightech Plc accept Project A today?

Hightech Plc is considering an alternative strategy (Project B). The company could alternatively invest the same amount of money today (i.e. 10 million) to purchase less specialised production machines with positive future salvage value. By following this path, the company would essentially gain the option to sell the machines next year (at time 1 and just after receiving the cash flow for time 1) and recover 8 million. Assuming that the perpetual cash flows and the cost of capital are the same as those in part d), should Hightech Plc accept Project B today? What is the value of the real abandonment option embedded in Project B that is not available in case of Project A?