Homework 4: Real options with a binomial tree You are considering the following project: 1. The initial investment is $100 million. 2. The net cash flow at time 1 is $20 million. 3. The net cash flow volatility after time 1 is 50%. 4. Require return rate is 10%. 5. The project lifelong 5 years. You will receive the new cash flow once a year. 6. Probability of cash-flow increasing from one year to the next is 51%, and the probability of cashflow decreasing is 49%. Option At time 3 , you have an option to sale the project at salvage value 40 million. Questions: 1. Design a binominal tree based on the information above. 2. Calculate the NPV with the abandonment option (what is the value of the option?) 3. What happens to NPV when cash-flow volatility increases to 60%