1. The decision to invest in the Mark II must be made after three years, in 1985.

2. The Mark II has an investment requirement of $955 million, which is taken as fixed.

3. Forecasted cash inflows of the Mark II have a present value in 1985 of $862 million and $499 million (862 / 1.23 = 499) in 1982.

4. The future value of the Mark II cash flows is highly uncertain. This value evolves as a stock price does with a standard deviation of 35% per year.

5. The annual interest rate is 11%.

Interpretation

The opportunity to invest in the Mark II is a three-year call option on an asset worth $499 million with an exercise price of $955 million.

How does the value of the option to invest in the Mark II in 1982 change if:

a. The investment required for the Mark II is $855 million (vs. $955 million)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. The present value of the Mark II in 1982 is $555 million (vs. $499 million)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. The standard deviation of the Mark II's present value is only 20% (vs. 35%)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)