A project has two phases each of one year duration. You pay 15 dollars today. The first phase has a 60% chance of success. If successful, the firm can pay 30 dollars for the second phase. The second phase has a 20% chance of being successful. In this case, the firm can pay 100 dollars. Viewed from date 0, the expected revenue in year 2 of a successful project is estimated to be 500 dollars.

The volatility of the logarithmic returns on the revenues is sigma = 0.693147. The riskless rate is zero. The risk of the project is fully diversifiable.

(a) Establish the lattice of present values for a successful project.

(b) Establish whether the firm should initiate the initial phase of this project. Also explain exactly what the firm should do in each stage of the project contingent on market and technical risk. What is the value of the project to the firm? Provide full details.

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