Reference no: EM133091831

Question - The Consumer-Mart Company is going to introduce a new consumer product. Due to the nature of the investment, you are uncertain about its future cash flows. If demand is high, net operating cash flows will be $100 million for 10 years (starting next year [i.e., at t = 1]). The probability of this event is 60%. On the contrary, if demand is low, net operating cash flows will be $30 million for 5 years (also starting next year). You will learn whether the new product is a success or a failure after the first year's cash flow is realized (i.e., at t = 1). The required initial investment is $400 million and the discount rate used by the firm is 12%.

Required -

a. Calculate the net present value of the project.

b. If demand is high, you can expand the project and invest $200 million more immediately after the first year's cash flow is received, to launch a complementary product. After this investment, net operating cash flows in the remaining years (i.e., in years 2 through 10) would be $150 million. Calculate the net present value of the project with this expansion option.

c. Calculate the value of the expansion option in b.