Why is there multi-generation iPod and why Steve just manage to launch a ugly iPod with black and white but not a color one. Positive NPV ? No, even the NPV is negative. Steve should still go ahead with it.
For the 1st gen. iPod, NPV of the project must be destroying values and should be a do if we just consider the static NPV of the project. ie the expected cash flow discounted using company 's WACC.
The strategy is used simply coz we can view this in a more dynamic way and treat the multi-generation product as a multistage option. The expected Free cash Flow FCF of 1st generation project could be viewed as the underlying asset of the option where as the next stage CAPEX as the strike .
Using Black Schole/Binomial tree, the option value of the strategy should be larger than initial investment of the 1st generation iPod. ie Creating values for shareholders.
The heart of this valuation is on the volatility estimate, I suppose the strategic analyst has asked Steve quite a few questions about the confidence of project. (eg probability of FCF larger expected FCF by 50 % and so and so). This could simply allows us to quantify the volatility of the project given some management 's intuitive and hidden information.
Life may be a multistage option too.
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