Question
17. Diplomat.com is considering a project that has an up-front cost of $3 million and is expected to produce a cash flow of $575,000 at
17. Diplomat.com is considering a project that has an up-front cost of $3 million and is expected to | ||||||
produce a cash flow of $575,000 at the end of each of the next 5 years. The project's cost of capital | ||||||
is 16%. What is the project's net present value? Answer: -$1,117,281.15 | ||||||
18. Refer to problem 17. If Diplomat goes ahead with this project today, it will obtain knowledge that will | ||||||
give rise to additional opportunities 5 years from now (at t = 5). The company can decide at t = 5 whether | ||||||
or not it wants to pursue these additional opportunities. Based on the best information available today, | ||||||
there is a 40% probability that the outlook will be favorable, in which case the future investment | ||||||
opportunity will have a net present value of $6 million at t = 5. There is a 60% probability that the outlook | ||||||
will be unfavorable, in which case the future opportunity will have a net present value of -$2 million | ||||||
(negative) at t = 5. Diplomat.com does not have to decide today whether it wants to pursue the additional | ||||||
opportunity. Instead, it can wait to see what the outlook is. However, the company cannot pursue the | ||||||
future opportunity unless it makes the $3 million investment today. What is the estimated net present | ||||||
value of the project after consideration of the potential future opportunity Answer: $25,390.09 | ||||||
19. Refer to problems 17 and 18. What is the value of the option to expand Diplomat.com's project | ||||||
from the decision-tree analysis you have completed in problems 17 and 18? | ||||||
20. Refer to problems 17 and 18. Next, we plan to use the Black-Scholes model to estimate the value of | ||||||
this option to expand the project at t = 5. Calculate P = current stock price = PV as of t = 0 of all | ||||||
expected future cash flows if the project is expanded at t = 5. | ||||||
21. Refer to problem 20. Now use the Black-Scholes model to estimate the value of this option to | ||||||
expand the project at t = 5. Use the P you calculated in problem 20, plus assume that the variance of | ||||||
the project's rate of return is 40% and that the risk-free rate of return is 5%. ***I need help with 19, 20, and 21. |
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