Johnno's Thermostats Co. sells equipment to residential and commercial customers. It is considering whether or not to develop a new line of advanced commercial thermostats. The discounted cash flows from commercial thermostat sales are not likely to cover the development costs. However, the company has decided to pursue the project anyway. If the commercial technology is successful, it might be applied to a new line of very profitable residential thermostats. This is an example of the option to make follow-on investments.

Question

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The scenario describes the option to make follow-on investments, where pursuing the commercial thermostat project may lead to the development of a profitable line of residential thermostats.