What type of real option is available to the cereal maker

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A breakfast cereal maker is considering introducing a gluten-free version of its best-selling breakfast cereal. Market research provided the following information: It will cost the company $8million to acquire the facilities needed to produce the new cereal. There is 60% chance that the new cereal will be popular with consumers. If it was popular, it will generate a net cash flow of $1million per year in perpetuity, otherwise it will generate $0.4million per year in perpetuity. If the product was unpopular, the company has the option to discontinue the product and sell the facilities for $8million after 1 year. The cost of capital is 10%.

-What type of real option is available to the cereal maker? Under what circumstances the option should be exercised?

-Should the company produce this new cereal?

-What is the value of the real option? Would the cereal maker's decision be different if the real option was not available?

Reference no: EM133069506

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