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Decision Tree Analysis: Investment Options

Marcal Corporation is considering foreign direct investment in Asia. The company estimates that the project would require an initial investment of $14 million. and generate positive cash flows of $2 million a year at the end of each of the next 20 years. The project's cost of capital is 12%.

a. Calculate the project's NPV.

b. The company thinks there is a 50-50 chance that the Asian country will impose restrictions on the company in one year. If the restrictions are imposed, cash flows will be $1,000,000 per year for 20 years. If restrictions are not imposed, cash flows will be $3,000,000 per year for 20 years. In either case, the cost will remain at $14,000,000. If the company waits one year, what is the project's NPV with restrictions and without restrictions.

c. Calculate the value of the option if the company waits one year. Should the company wait or go ahead with the project now?

d. Discuss 2-3 factors other than the value of the real option that the company should consider in making its decision.

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Solution Summary

The Solution includes a decision tree to compare alternate investment options.

Solution provided by:
Robert Reinhart, MBA
Education
  • MBA, Merage School of Business, Univ of Cal, Irvine
  • BA, Univ of Cal, Irvine
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