Decision Tree Analysis Shows a Project to Have Several Possible

question 19

Multiple Choice

Decision tree analysis shows a project to have several possible outcomes the best of which has an NPV of $12M calculated over a five-year life. This best case path has an overall probability of occurring of 20%. A real option is available at an initial cost of $800,000 which will add a single $6M cash inflow to this best case path at its end. The option doesn't have a significant effect on the project's risk. What is the option's value? The company's cost of capital is 12%.

• A)($3,404)
• B)$2,604,000
• C)($119,000)
• D)$274,000

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Definitions:

High Winds

Strong and often destructive air movement in the atmosphere, capable of causing damage to structures and impacting weather patterns.

Acid Rain

Low-pH rain that forms when sulfur dioxide and nitrogen oxides mix with water vapor in the atmosphere.

Sulfur Dioxides

Sulfur dioxide (SO2) is a toxic gas with a pungent, irritating smell, released by volcanoes and industries, and contributing to acid rain.

Nitrogen Oxides

Compounds formed by the reaction of nitrogen and oxygen gases in the air during combustion, especially at high temperatures.