ACC is considering building a cement manufacturing plant in Sri Lanka.

ACC is considering building a cement manufacturing plant in Sri Lanka. The project will cost Rs 800 crore and the present value of the cash flows will be Rs 700 crore. The finance director is not in favour of the proposal since it has a negative NPV. The marketing director, on the other hand, thinks that the potential market for cement in Sri Lanka is enormous. He argues that the company should build the plant now to establish it competitive position and expand after 3 years. The cost of expansion will be Rs 2,000 crore and the present value of cash flows will be Rs 2,100. The demand for cement is expected to fluctuate. The standard deviation of the values of cash flows is estimated to be 32 per cent. The risk-free rate is 7.5 per cent. What is the value of the option to expand?

 

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