BMAN23000(B) MayJune 2013

1. b) You own a small manufacturing plant that currently generates revenues of 2 million per year. Next year, based upon a decision on a long-term government contract, your revenues will either increase by 20% or decrease by 25%, with equal probability, and stay at that level as long as you operate the plant. Other costs run to 1.6 million dollars per year. You can sell the plant at any time to a large conglomerate for 5 million and your cost of capital is 10%.
   1. If you are awarded the government contract and your sales increase by 20%, what will be the value of your plant?
   2. Given the embedded option to sell the plant, what will be the value of your plant?
   3. Assume that you are not able to sell the plant, but you are able to shut down the plant at no cost at any time. What is the value of the option to abandon production?