) An investment project requires an initial investment of $500 at time zero. If the...
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) An investment project requires an initial investment of $500 at time zero. If the firm invests in the project, there is 70% chance that a competitor will enter. The firm estimates that it will receive cash flows of $700 at t = 1if the competitor enters and $1,200 if not. In the case where the competitor does not enter at this point, there is also a 70% chance that the competitor will enter. The firm estimates that it will receive cash flows of $700 at t = 2 if the competitor enters and $1,200 if not. Meanwhile, the firm has the option to expand operations by investing an additional $300. If the manager decides to expand at t = 1, there is still a 60% chance that a competitor will enter. The firm estimates that it will receive cash flows of $400 at t = 2 if the competitor enters and $2,400 if not. In the case where the competitor does enter from t = 0 to t = 1, there is a 30% chance that the firm will get $1,100 at t = 2 and a 70% chance that it will get $600 at t = 2. Assuming a required rate of return is 10%. a. What is the NPV at 0 if the option to expand does not exist? (20 points) b. What is the NPV at 0 if the option to expand exists? (20 points)
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