3. Consider a project whose cash flows are as follows:

Chapter 18 - Real Options Financial Modeling, Second Edition Simon Benninga Copyright © 2000 Massachusetts Institute of Technology Year Cash Flow of Single Machine 0 −550 1 100 2 200 3 300 4 400

a. Using the state prices, value the project.

b. Suppose that at date 2 the project can be abandoned at no cost. What does this fact do to its value?

c. Suppose that at any time the project can be sold for $100. Show the tree of cash flows and value the project.