Estimate the npv of the option to expand

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Reference no: EM132021673

A Canadian firm is evaluating a project in the United States. This project involves the establishment of a lumber mill in Wisconsin to process Canadian timber. The factory expects to service clients in the construction industry. All cash flow figures are in thousands. Initial Investment. The initial investment is CAD 48,000. The project is over a period of three years. This investment will be depreciated straight line to zero. Operating Results. The firm expects two likely scenarios for the first year of operations. Under the favorable scenario (probability of 45%), the firm expects to produce and sell 1,400 units of a product. Under the unfavorable scenario (probability of 55%), it expects to produce and sell only 800 units. The selling price is expected to be CAD 55; the variable expense is expected to be CAD 27, and fixed costs excluding depreciation are expected to be CAD 15,000. Additional Investment. If the firm encounters the favorable scenario during year 1, it could make an investment of CAD 25,000 to enable it to produce and sell a total of 2,800 units (double the units) in the second and third years. The cost parameters remain unchanged with the exception of depreciation. This secondary investment will be depreciated equally in years 2 and 3. If the firm chooses not to make the investment in year 1, the results of year 1 will be repeated during years 2 and 3. Discount Rate and Miscellaneous. Assume a discount rate of 11 percent and zero taxes.

a. Estimate the NPV of the project.

b. Estimate the NPV of the option to expand.

Reference no: EM132021673

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