Question
Dreamline Company is a leading firm in the heavy machines sector, manufacturing plants for both corporate entities and the government. Following a successful government policy,
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Dreamline Company is a leading firm in the heavy machines sector, manufacturing plants for both corporate entities and the government. Following a successful government policy, Dreamline is in line to win a big contract to manufacture plants for waste recycling across the country. The companys most recent revenue is 2 million per year; this revenue will potentially increase by 20% or decrease by 25% depending on the outcome of the bid for the contract. There is an equal probability of the revenue increase or decrease. It will also cost 1.6 million annually to run the plants. However, Dreamline has the option to sell the plants to another company for 5 million. The cost of capital is 10%.
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Find the value of the plant given the embedded option to sell the plant.
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Assume that Dreamline is not able to sell the plant, but it is able to shut down the plant at no cost at any time. What is the value of the option to abandon production?
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Assume that it will cost the firm 1 million to shut down the plant, but it is able to sell the plant for 5 million at any time. Determine the value of the option to sell the plant.
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Draw a decision tree assuming Dreamline is not able to sell the plant, but it is able to shut down the plant at no cost at any time.
(60 marks)
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