Suppose you can invest in a business project and the cost of this project is 3.5 million dollars. And if you are not sure how much to order in the future. There is a 40% chance that the demand will be high and the present value of the company will be $3.7 million in this case. There is a 25% chance that the demand is moderate, and the associated present value is $2.5 million. Finally, there is a 35% chance of a decrease in demand, in which case the present value would be $1.5 million.

1. Draw a decision tree for this problem. What is the expected net present value of the project? Should you invest? to explain.

2. Suppose you can expand this project by investing an additional $0.6 million after you know what the real demand is in the future. This would make the present value of the business $3.9 million in the case of high demand, $3.5 million in the case of moderate demand, and $1.8 million in the case of low demand. Draw a decision tree to reflect the scaling option and evaluate the alternatives. What is the net present value of the business if you are considering the expansion option? What is the value of the expansion option?