A chemical manufacturer is setting up capacity in Europe and North America for the next three years. Annual demand in each market is 2 million kilograms (kg) and is likely to stay at that level. The two choices under consideration are building 4 million units of capacity in North America or building 2 million units of capacity in each of the two locations. Building two plants will incur an additional one-time cost of $2 million. The variable cost of production in North America (for either a large or a small plant) is currently $10/kg, whereas the cost in Europe is 9 euro/kg. The current exchange rate is 1 euro for U.S. $1.33. Over each of the next three years, the dollar is expected to strengthen (NOT rise) by 10 percent, with a probability of 0.5, or weaken (NOT drop) by 5 percent, with a probability of 0.5. Assume a discount factor of 10 percent.
1. What is the Year 0 net present value of building 2 million units of capacity in each of Europe AND North America?
2. What is the Year 0 net present value of building 4 million units of capacity in North America?