a. What is the net present value( NPV) of the investment under the current required rate of return? b. What is the net present value( NPV) of the investment under a period of rising inflation? c. What is the net present value( NPV) of the investment under a period of falling inflation? d. From your answers in a, b, and c, what relationship do you see emerge between changes in inflation and asset valuation?
P12 – 17 Real options and the strategic NPV Jenny Rene, the CFO of Asor Products, Inc., has just completed an evaluation of a proposed capital expenditure for equipment that would expand the firm’ s manufacturing capacity. Using the traditional NPV methodology, she found the project unacceptable because LG 6 NPVtraditional = − $ 1,700 < $ 0 Before recommending rejection of the proposed project, she has decided to assess whether there might be real options embedded in the firm’ s cash flows. Her evaluation uncovered three options: Option 1: Abandonment. The project could be abandoned at the end of 3 years, resulting in an addition to NPV of $ 1,200. Option 2: Growth. If the projected outcomes occurred, an opportunity to expand the firm’ s product offerings further would become available at the end of 4 years. Exercise of this option is estimated to add $ 3,000 to the project’ s NPV. Option 3: Timing. Certain phases of the proposed project could be delayed if market and competitive conditions caused the firm’ s forecast revenues to develop more slowly than planned. Such a delay in implementation at that point has an NPV of $ 10,000. Jenny estimated that there was a 25 % chance that the abandonment option would need to be exercised, a 30 % chance that the growth option would be exercised, and only a 10 % chance that the implementation of certain phases of the project would affect timing.
a. Use the information provided to calculate the strategic NPV, NPVstrategic, for Asor Products’ proposed equipment expenditure.