(25–4)

Real Options: Decision-

Tree Analysis Utah Enterprises is considering buying a vacant lot that sells for $1.2 million. If the property is purchased, the company’s plan is to spend another $5 million today (t = 0)

to build a hotel on the property. The after-tax cash flows from the hotel will depend critically on whether the state imposes a tourism tax in this year’s legislative session.

If the tax is imposed, the hotel is expected to produce after-tax cash inflows of

$600,000 at the end of each of the next 15 years, versus $1,200,00 if the tax is not imposed. The project has a 12% cost of capital. Assume at the outset that the company does not have the option to delay the project. Use decision-tree analysis to answer the following questions.