Question
Assumptions 1. The decision to invest in the Mark II must be made after three years, in 1985. 2. The Mark II has an investment
Assumptions | ||
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 $940 million, which is taken as fixed. | |
3. | Forecasted cash inflows of the Mark II have a present value in 1985 of $847 million and $490 (847 / 1.23 = 490) million 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 43% per year. | |
5. | The annual interest rate is 9%.
| |
Interpretation | ||
The opportunity to invest in the Mark II is a three-year call option on an asset worth $490 million with an exercise price of $940 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 $840 million (vs. $940 million)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Option value =
b. The present value of the Mark II is 1982 is $540 million (vs. $490 million)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Option value =
c. The standard deviation of the Mark II's present value is only 28% (vs. 43%)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Option value=
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