Based upon the following inputs, propose the optimal course of action for this venture:
- Probability of success: 30%; probability of failure: 30%; base case probability: 40%
- Cost of initial investment is $20mm
- Success NPV: $70mm; Base case NPV: $25mm
- Two upfront options:
- Staged investment of $10mm/stage; no impact on probabilities or scenario NPV but allows abandonment after first stage investment in case of anticipated failure
- Deferral of investment by 1 year to pursue $3mm feasibility study; decreases odds of failure by 10% and shifts odds evenly to success and base case
- Two midpoint options (assumes either success or base case scenario):
- Operate venture indefinitely and realize full NPV
- Reinvest for new market expansion under the same terms as the upfront option with the following changes:
Chance of success is lowered by 5% and chance of failure is increased by 5%
Upfront cost is higher by $5mm but PV of future cash flows remains unchanged