3. You love rock-climbing and the thought of running a business... so you are thinking about combining your two passions and purchasing a mountain guide company! You have found an established business that can be purchased for $14 million.1 You realize that there are different possible outcomes for this business. If mountain climbing becomes more popular (probability 35%), the business will generate FCFS of $2.5 million next year, with growth of 4% into perpetuity. If the popularity stays constant (probability 35%), FCFS from the business will be $1.2 million next year with 2% growth into perpetuity. Andif its popularity declines (probability 30%), it will generate only $0.5 million per year in FCF into perpetuity (with no growth). In analyzing this investment, you discover that you can purchase an option today to sell the company back to the current owners after exactly one year for $12.1 million. But to obtain this option, you would have to purchase the business for $16 million instead of $14 million. The discount rate for this investment is 12%. What should you do regarding this business opportunity? (20 pts)

There are three different outcomes with difference in the expected future free cash flows.

Scenario 1 (Popular):

Probability of 35%, free cash flow next year of $2.5 million which will grow at a rate of 4% in to perpetuity.

Value of the free cash flow () is calculated as below:

Scenario 2 (Constant):

Probability of 35%, free cash flow next year of $1.2 million which will grow at a rate of 2% in to perpetuity.

Value of the free cash flow () is calculated as below:

Scenario 3 (declines):

Probability of 30%, free cash flow next year of $0.5 million forever.

Value of the free cash flow () is calculated as below: