Question. A retail development project runs for 2 periods before the completed property is sold at a fair price. Its present value without flexibility is $40 million, and the initial investment is $25 million. The annual volatility of the project’s present value is expected to be 20% and its WACC is 12%.
At the end of the second period there is an option to expand, increasing the value of the development project by 30% by investing an additional $10 million.
The risk free rate is 5%.
(a) What is the project’s NPV without the option to expand?
(b) What is its ROA (real option analysis value) with the option to expand?