Pegasus Inc. wants to estimate the present value of project

X. All production and sales take place one year from now, and there is

no option to shut down production. Project X will produce 50 (million)

widgets in all states of the world. The price of widgets next year will

depend upon demand conditions. If demand is high, each widget will sell

for $200. If demand is low, each widget will sell for $100. There are two

inputs into the production process: labor and oil. Labor costs at time 1

are equal to $20 per widget. The folks over in production indicate that

each widget produced requires one barrel of oil at time 1. The folks over

in marketing and sales indicate that the performance of the stock market

is a perfect predictor of demand for widgets, i.e., the demand for widgets

is high when the market return is high. You have been asked to value the

project. The following pieces of information may be useful to you.

There are no taxes. The historical equity beta for Pegasus is 1.2. Pegasus

has historically maintained a debt to equity ratio of 1/2. The spot price

of oil one year from now will be either $50 or $40 depending on condition

of world oil markets. The forward price for barrel of oil, deliverable one

year from now, is $45. One unit of the (market) S&P 500 index can be

purchased for $1000 today. The S&P will be worth either $1500 or $900

next year. The risk-free rate is 5%. The historical average return on the

market portfolio is 12%.

What is the most you would be willing to pay for the rights to the project?