The current static NPV of a construction project is $500. The risk-free rate is 5% per year and the volatility of the project is 20% per year. In four years, there is an opportunity to expand the project by 40% at a cost of $150. You may also abandon the project for $300 (salvage value) in four years.

a) Construct a two-step binomial tree for the construction project and use the real option valuation approach to compute the value of the expansion option connected to this project. Assume continuous time discounting.

b) Use the two-step binomial tree constructed in a) and use the real options valuation approach to compute the value of the option to abandon connected to this project. Assume continuous time discounting.

c) What is the value of a chooser option connected to the above real investment project.