King Ltd is a brewing company that was established 3 years ago. When it commenced operations, management purchased a bottling machine for $1.2 million. This machine has the ability to be converted so that it also inserts corks into wine bottles. The conversion costs $250,000. An equivalent machine without the ability to be converted so that is also seals wine bottles, would have cost $800,000.

1. Define the option described above (i.e. name it and label it as either a put or a call option).
2. In addition to the risk-free rate of return and the term to expiry, the following four characteristics have been shown to affect the value of an option:
   1. current value of asset.
   2. Exercise price of the option
   3. volatility of asset returns over the life of the option
   4. dividends of asset returns over the life of the option.

Describe these characteristics in relation to the option possessed by King Ltd.

C. The 'premium' for a financial option is the price paid to acquire it. Is there any premium associated with the real option described above?

D. Are there any circumstances in which King Ltd may exercise its option early? Explain the advantages and disadvantages associated with early exercise.