Growth Option for Martin Development: Project X's NPV, value of growth option
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13-1(Growth Option) Martin Development Co. is deciding whether to proceed with
Project X. The cost will be $9 million in Year 0. There is a 50% chance that X will be hugely
successful and will generate annual after-tax cash flows of $6 million per year during
Years 1, 2, and 3. However, there is a 50% chance that X will be less successful and will
generate only $1 million per year for the 3 years. If Project X is hugely successful, it will
open the door to another investment, Project Y, that will require a $10 million outlay at the
end of Year 2. Project Y will then be sold to another company at a price of $20 million at
the end of Year 3. Martin's WACC is 11%.
a. If the company does not consider real options, what is Project X's NPV?
b. What is X's NPV considering the growth option?
c. How valuable is the growth option?
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Solution Summary
The expert examines growth options for Martin Development for the project X's NPV.
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