Real options and the sarategic NPV Jenny Rena the CFO of Aso

Real options and the sarategic NPV Jenny Rena, the CFO of Asor Products, Inc, has just complieted an evaluation of a proposed capital expendture for equipment that would expand the fm\'s manufacturing capacity. Using the tradsonal NP modology she found the project unacceptable because PVaonal-$1,686 Befgre recommending rejection of the proposed project she has decded to assess whether thene might be real opons embedoed in the fim\'s cash ows. Her evaluaton uncovered three options and their probabity Opton t Abandonment The project could be abandoned at the end of 3 years, resuting in an addtsion to NPV of $1,040 Opton 2 Grow-ifthe projected outcomes occurred, an opportunity to axpand the fien\'s product oferings turher would occur at the and of 4 years. Exarcise of this aption is estimated to add $2 550 to the projacts NPV imingCerin phases of the proposed project could be delayed it market and competive conanons cauted them\'s forecast nevenues to develop more slowty than planned Such a dlay in implementatio at that point has an NPV on yest ated that there was a 20% da et atte aband nem ooton wou need to be e erosea a 35% chancenatthego tapton woud bee erased and on y a 10% chance at the impleme tation of certar phases one prject Ould a ect a Use the information provided to calalane the strategc NPV NPor Asor Products proposed equipment expendture b. Judgng on the ba5?your tongs pat (ai what acton shoad Jerry recommend to managerment wth regard to the proposed equpment expenonne? a. The value of the neal options is Round to he naarest doltlar The straegie NPVisRound to the nearest da b. Judging trom your findings in part (a),hat action should Jenny recommend to management wih negand to the proposed equipment expenditure? Seled om the drop-doun menu

Solution

a) value of the real options = value of abandonment + value of growth + value of timing 1040*20%+ 2550*35%+10500*10% = 2151 strategic NPV is = Npv traditional + value of real options = (-1656+2151) = 495 b) on the basis of (a) she should recommend that the expenditure is acceptable