Reference no: EM132920594

Real Option to Expand:

In the beginning of 2019, Futuristic Digital Inc (FDI) was considering whether it should invest in developing/manufacturing 3D printers. Notwithstanding the negative NPV based on traditional DCF approach, FDI management wishes to estimate the value of real option embedded in this project.

Relevant information is given as folllows:

• This project will allow FDI to expand further into the emerging market of 3D printer if it turns out to be a boom in the future. If FDI will choose to expand, such action can be acted upon in the beginning of 2022 (e.g. 3 years from now)
• The initial outlay for the follow-on project (3 years from now) is -200 million$ and this is certain.
• The PV of future cash flows of the follow-on project at the beginning of 2019 is estimated as 106.77 million$. The discount rate that reflects the riskiness of the follow-on project is 12% per year.
• The relevant government bond rate is observed as 6% per year.
• Finally, the variance (v2 ) of stock returns in the high-tech industry is about 25%.

N(-0.08391) = 0.466564

N(-0.94994) = 0.171073

N(0.45321) = 0.674801

N(0.27261) = 0.6607423

N(d1 = ?) = 0.764241 N(d2 = ?) = 0.576552

Required

Problem 1: Calculate the real option value embedded in the 3D printer project that FDI was considering in the beginning of 2019