You company is evaluating a project which costs $1 million today. With an 80% probability it will
Question:
You company is evaluating a project which costs $1 million today.
With an 80% probability it will succeed and generate a perpetual annual cash flow of $200,000.
With a 20% probability it will fail and make a perpetual annual loss of $5,000.
In the next year, it will become clear whether the project will succeed before the first cash flow is realized. Your company has an option to forfeit the on-going project and switch to a backup project in year one.
The back-up plan, if carried out, will cost $250,000, and starting year two, it will generate a perpetual annual cash flow of $80,000 with a 60% probability and a perpetual annual loss of $10,000 with a 40% probability.
Assume an annual discount rate of 10%.
What is the value of this option?
Introduction to Data Mining
ISBN: 978-0321321367
1st edition
Authors: Pang-Ning Tan, Michael Steinbach, Vipin Kumar