Real Options Homework

Real Options Homework

Please refer to Practice Problem I (not the "more difficult" one).

The assignment is to evaluate both parts, the traditional NPV calculation as well as the Real Options approach. The probability of a successful project (or pilot) is now .7 (instead of .5) and the probability of an unsuccessful project is .3 (instead of .5).

Also, the perpetuity in the "bad" case is now $1.5 million per year, not $2 million.

What is the expected NPV in each case now? What do you recommend? Why?

If you don't know the probability of success for the pilot, is there a value that is critical to your recommendation? Is there a probability of success above or below which you will recommend undertaking the pilot and below or above which you will recommend a go/ no go decision on the underlying project without undertaking a pilot test?