Question 1
You plan to build an automobile factory in India for $30M. You will produce and sell 5,000 cars per year for ten years, starting at t=2. The price per car at t=2 will either be $20,000 or $30,000, with equal probability, and the price will stay at that level indefinitely. The cost of producing each car will always be $22,500, and these costs will be incurred starting at t=2 as well.
a) What is the NPV of the expected cash flows from this project? Assume a discount rate of 20%.
b) You purchase this factory with the reasoning that it is a strategic investment. Specifically, you know that you have the option to produce five times as many cars starting at t=2, and that you learn how much your cars will sell for at t=1 (revenues and costs still begin at t=2). If you exercise the option, you will produce 25,000 cars per year from t=2 to 11. Otherwise, you will produce 5,000 cars per year from t=2 to 11. What is the NPV of the expected cash flows from this project if you have the option to sell five times as many cars from t=2 to 11?