Jim Beam is considering investing $ 10 million to create a new whiskey based on

Question

Jim Beam is considering investing $ 10 million to create a new whiskey based on George Washington original recipe using authentic Revolution War-era equipment. If successful, Beam plans to expand the line to include a whole line of historic distilled spirits. A nancial analysis of the cash ows from the Washington whiskey investment suggests that the present value of the cash ows from this investment to Jim Beam will be only $ 7 million. Thus, by itself, the new channel has a negative NPV of $ 3 million. If the market for the Washington spirit turns out to be more lucrative than currently anticipated, Jim Beam could expand its historical spirit line with an additional investment of $ 15 million any time over the next 20 years. This scenario is best described as... Option to delay/ Option to expand/Option to abandon/Put option? explain it.

Explanation / Answer

This scenario is best described as option to expand.

The project of making whisky based on George Washington original recipe is financially not feasible and on a stand alone basis, should be rejected. This is because the net present value is negative.

Now, Jim Beam is considering to expand as he thinks the market for George Washington whisky can become more robust in future. He is taking a chance here, a chance to expand. Obviously, risks are involved and his decision to expand may back fire if the markets do not grow more aggressively in the future.

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