The Ferret Pet Company is considering a new location. If it constructs an office and 100 cages, the cost will be $100,000 and the project is likely to produce net cash flows of $17,000 per year for 15 years, after which the leasehold on the land expires and there will be no residual value. The company's required return is 18 percent. If the location proves favorable, Ferret Pet will be able to expand by another 100 cages at the end of 4 years. The cost per cage would be $200. With the new cages, incremental net cash flows of $17,000 per year for years 5 through 15 would be expected. The company believes there is a 50-50 chance that the location will prove to be a favorable one.
a. Is the initial project acceptable?
b. What is the value of the option? the worth of the project with the option? Is it acceptable?
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