Question

The change to consider is this: suppose that the value of the hotel is one of two values: $9.2 million if the city is successful in obtaining the franchise (and not $8 million as in the original problem) or $3.5 if the city is not successful in obtaining the franchise (and not $2 million as in the original problem).  

All other aspects of the problem are the same as originally presented, such as the costs per year. Assume that the probability of obtaining the franchise is 50%. Incorporating these new hotel values from above, and the real option, what is the new NPV of the project?

$ million

Place your answer in millions of dollars using at least three decimal places. For example, the answer of nine hundred seventy five thousand would be entered as 0.975 and not as 975000.

Answer 1

Computation of Net Present Value of the Project

We know that Net Present value in Probability Distribution is = NPV * Probability

Case	Probability	Present Value	Probability * Present Value
Successful in obtaing a Franchise	0.5	$9,200,000	$ 9200000*0.5=$ 4600000.
Not successful in obtaing a Franchise	0.5	$3,500,000	$ 3500000*0.5=$ 1750000
	Total		$6,350,000.00

Given the Probability of Obtaining a license is 0.5

We know that Sum of the Probabilities is 1

Then Probability of not getting a License is 1-0.5= 0.5

Hence the Net Present Value of the Project is $ 6.35 Millions