CherryBerry is considering opening a location on the east side of Mexico City. The firm is uncertain about the success of the venture due to uncertainty about demand for its frozen yogurt products in Mexico. Opening the store would require an initial investment of $500,000. The firm estimates that there is a 60% chance that the store will be successful and generate cash flows of $200,000 per year, forever. There is a 40% chance that the store will be a failure and generate cash flows of only $50,000 per year, forever. If the store is successful, this would open the door to an opportunity to open another CherryBerry location on the west side of Mexico City. This second location would require an investment of $500,000, which would occur one year after the start of the first store (i.e., Year 1). If the first store is successful, this second store would also be successful and generate cash flows of $200,000 per year, forever. Given the risk of this venture, CherryBerry estimates that a discount rate of 20% is appropriate.
1. What is the NPV of the project, ignoring the embedded expansion option? Round your final answer to the nearest dollar.
a. 125,000 b. -125,000 c. 200,000 d. 175,000 e. 450,000
2. What is the value of the embedded expansion option? Round your final answer to the nearest dollar.
a. 250,000 b. 208,333 c. 200,000 d. 100,000 e. 150,000