Option to Wait Versus Immediate Investment Global Investments has hired you as a financial consultant to advise
Question:
Option to Wait Versus Immediate Investment Global Investments has hired you as a financial consultant to advise them on whether to enter the shoe market, an investment opportunity that has an initial outlay of £35 million. During a board meeting, the CEO tells you that due to the upcoming summer season there is high demand in the shoe market, and he believes the time is right to open a shoe business today. However, with the country hosting a major sporting event next summer, the finance director of the company argues that waiting exactly one year from now would also be a good opportunity. He argues that in one year from now there should be even higher demand, and hence shoes can be sold at higher prices.
After a further meeting with the company’s management, you are given the following information:
• The value of a shoe company is estimated to be £40 million.
• Due to a high degree of market competition the flow of customers is uncertain, so the value of the company is volatile, and based on the standard deviation of the company’s stock price you estimate this to be 25 per cent per year.
• 15 per cent of the value of the company is attributable to the value of the free cash flows expected in the first year.
• The one-year risk-free rate is 4 per cent.
The board cannot reach agreement, and so they ask for your opinion on when and if the company should go ahead with the project. What is your recommendation? Should they wait or invest?
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