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Fractal Corp. is considering an investment in a new high technology venture. The cost today if the investment is undertaken will equal $130 million.
Fractal Corp. is considering an investment in a new high technology venture. The cost today if the investment is undertaken will equal $130 million. Assume the project must be undertaken now or else it will be lost forever (there is no option to delay). The company estimates that the static total present value of the expected cash flows for the project if undertaken today equals $125 million. Fractal regards this project as unusual and believes that they will know at the end of the first year (time 1) of operation whether the project will succeed or not. Hence Fractal has made arrangements that if the project does not work out that the assets of the project can be liquidated and sold for an after tax cash flow of $120 million at the end of 1year. The underlying annual volatility of the value of the venture is expected to be 20%. The decision about whether to exit (abandon the project) will be made at the end of 1 year, but after that the company will not have that option any longer and the option will not be replaced by any other options. There are no other embedded real options in this project. The current annual continuously compound risk free interest rate equals 4% . Compute the expanded NPV of the project (the standard NPV plus the value of the option).