NS Vaccine is considering an investment in a new production facility. For the next 5 years, the

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Question:

NS Vaccine is considering an investment in a new production facility. For the next 5 years, the company expects to achieve an annual cash flow of $500 million in a boom scenario, $200 million in a normal scenario, and $100 million in a recession scenario. Boom scenarios occur 25% of the time, and normal scenarios occur 50% of the time. Cash flows occur at year-end. The initial investment required is $1,000 million. The relevant discount rate is 10 percent. Note: conduct the analysis in $ million and keep only two decimals.

a. Assume there is an option to expand the project. Expanding the project requires an additional investment of $500 million in year 1.

If the project is expanded, cash flows will increase by 50% from year 2 through year 5. In addition, assume there is an option to downsize the project.

Downsizing the project will result in recovering half of the initial investment in year 1 (i.e., you receive $500 million in year 1 from selling some the equipment already purchased at time 0). If the project is downsized, cash flows will decrease by 50% from year 2 through year 5. Under which scenario(s) the project should be expanded or downsized?

What is the NPV of the project with both options included?

In answering, do not compute the options values.

b. What is the value of the option to expand the project? Show your work.

c. What is the value of the option to downsize the project?

d. What is the NPV of the new project without the options? Answer this question is two different ways

e. Assume there is no option to expand or downsize the project. In addition, assume there is an option to delay the project by one year. If delayed, the initial investment will drop to $900 in year 1 and the project will last for 4 years only (i.e., the fifth cash flow is lost).

What is the value of the option to delay the project? Show your work.