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Bradford Services Inc. ( BSI ) is considering a project with a cost of $ 9 million and an expected life of 3 years. There
Bradford Services Inc. BSI is considering a project with a cost of $ million and an expected life of years. There is a probability of good conditions, in which case the project will provide a cash flow of $ million at the end of each of the next years. There is a probability of medium conditions, in which case the annual cash flows will be $ million, and there is a probability of bad conditions with a cash flow of $ million per year. BSI uses an cost of capital to evaluate projects like this.
c Now assume that the project cannot be shut down. However, expertise gained by taking it on would lead to an opportunity at the end of Year to undertake a venture that would have the same cost as the original project, and the new project's cash flows would follow whichever branch resulted for the original project. In other words, there would be a second $ million cost at the end of Year followed by cash flows of either $ million, $ million, or $ million for the subsequent years. Use decisiontree analysis to estimate the value of the project, including the opportunity to implement the new project at Year Assume that the $ million cost at Year is known with certainty and should be discounted at the riskfree rate of Enter your answer in millions. For example, an answer of $ million should be entered as not Round your answer to two decimal places.
d Now suppose the original project no abandonment option or additional growth option could be delayed a year. All the cash flows would remain unchanged, but information obtained during that year would tell the company exactly which set of demand conditions existed. Use decisiontree analysis to estimate the value of the project if it is delayed by year. Hint: Discount the $ million cost at the riskfree rate of because the cost is known with certainty. Enter your answer in millions. For example, an answer of $ million should be entered as not Round your answer to two decimal places.
e Go back to part c Instead of using decisiontree analysis, use the BlackScholes model to estimate the value of the growth option. The riskfree rate is and the variance of the project's rate of return is Enter your answer in millions. For example, an answer of $ million should be entered as not Round your answer to two decimal places.
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