You are the CEO of your company. The Research and Development Department of your company has made a signifi

[answerhappygod]

You are the CEO of your
company. The Research and Development
Department of your
company has made a significant progress in a new technology. You
are considering a pilot
program using this technology to produce a brand-new product. This
pilot program will last for
one year and cost £500 million. You believe the pilot program has a
50% chance to succeed
and 50% chance to fail.
If it succeeds, you will invest £3000 million in Year 1 to build up
a complete product line, which will generate free cash flows of
£400 million in perpetuity beginning in Year 2.
If it fails, you can still build the product line but the expected
free cash flows will only be £200 million in perpetuity beginning
in Year 2. Alternatively, you do not build the complete product
line but sell the technology for £300 million, i.e. giving up the
product. The cost of capital is 10%.
Required:
(a)You understand that the pilot program is in fact a real
option in this project. Please calculate the value of this real
option under the conditions in Part i.


(b )You also consider a plan alternative to that in Part i. In
particular, you skip the pilot program and build
up the complete product line
directly at a cost of £3000
million. Assume that with a 50%
chance it will generate free
cash flows of £400 million in
perpetuity beginning in Year 1 and with a 50% chance it will
generate free cash flows of £200 million in perpetuity beginning in
Year 1. The cost of capital is 10%. Please calculate the NPV
assuming the pilot program is skipped.