Question
A project requires an investment of $450 million and has expected annual cash flows of $74 million in perpetuity, starting in one year. The appropriate
A project requires an investment of $450 million and has expected annual cash flows of $74 million in perpetuity, starting in one year. The appropriate discount rate for the project is 15%.
The company can delay the project by 1 year. After 1 year, the company can invest $450 million to start the project and will know whether demand will be high or low. With high demand, future cash flows will be $89 million in perpetuity, starting in year 2, and $62 million otherwise.
The risk-free rate is 3%.
What is the NPV of the project ignoring the option to delay (in $ million)?
What is the value of the project after one year in the down state without delay (in $ million)?
What is the down factor (d) in the binomial option valuation model? Hint: It should be a number between 0 and 1.
What is the risk-neutral probability of the up movement?
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