27. Chrustuba Inc. is evaluating a new project that would cost $9 million at t =

Question

27. Chrustuba Inc. is evaluating a new project that would cost $9 million at t = 0. There is a 50% chance that the project would be highly successful and generate annual after-tax cash flows of $6 million during Years 1, 2, and 3. However, there is a 50% chance that it would be less successful and would generate only $1 million for each of the 3 years. If the project is highly successful, it would open the door for another investment of $10 million at the end of Year 2, and this new investment could be sold for $20 million at the end of Year 3. Assuming a WACC of 8.75%, what is the project's expected NPV (in thousands) after taking this growth option into account?

e.)$3,136

Explanation / Answer

Hi, Restating the answer. NPV = -9000000 + 6000000/(1+.0875)^1 + 6000000/(1+.0875)^2 + 6000000/(1+.0875)^3 = 6255693.60 If growth option is taking into account: NPV = -9000000 + 6000000/(1+.0875)^1 - 4000000/(1+.0875)^2 + 26000000/(1+.0875)^3 = 13350573.95 Increase in NPV = 13350573.95 - 6255693.60 = 7094880.35*.50 = 3547 which is closest to 3447. Option D is correct. Thanks

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