Aston Technologies is bringing a new product to market. It will require an investment of $200,000 today. The firm expects to sell 1,000 units per year at $26 each, for the next twenty years. Expenses are zero, and you can ignore taxes. The relevant discount rate is 12%.
(a) compute the NPV of the project based on the expected cash flows.
Demand for this product is uncertain, and the uncertainty will be resolved at the end of the first year. Management estimates a 60% probability that demand will be high, and the firm will sell 1,500 units per year. If demand is low, 500 units per year will be sold. In either case, the price will be $26. At any time after the first year, the firm can sell the technology for $120,000.
(b) recompute the NPV of the project based on this additional information.
(c) what is the value of the "real option" embedded within this project?