Question
HCB, Inc. is considering investing in a new 'We're # 1' foam hand cutting facility. If UT wins the SEC Championship, the cash flows will
HCB, Inc. is considering investing in a new 'We're # 1' foam hand cutting facility. If UT wins the SEC Championship, the cash flows will be $400,000 per year for 5 years. If UT does not win, then the cash flows will be $100,000 per year for 5 years. The probability of UT winning the SEC championship is 20% and the probability of not winning is 80%. It will cost $1,100,000 to purchase the equipment. If HCB waits 1 year to invest, then they will know if UT has won the championship or not, and hence which cash flows will occur. The risk free rate is 6% and the cost of capital is 10%. You would like to use the Black-Scholes Option Pricing Model to value this investment.
16. Using a decision tree, find the expected NPV of the project if you wait.
a. $68,146
b. $70,191
c. $72,917
d. $75,643
e. $77,687 The answer is a. 68,146. Could someone explain how to do this?
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