Problem 1: (25 points) Assume that you have just been hired as a financial analyst by Tropical Sweets Inc., a mid- sized California company that specializes in creating exotic candies from tropical fruits. The firm's CEO has asked you to prepare a brief on possible outcomes of the project the company is planning. a) Tropical Sweets is considering a project that will cost $120 million and will generate expected cash flows of $62 million per year for three years. The cost of capital for this type of project is 10% and the risk-free rate is 6%. After discussions with the marketing department, you learn that there is a 60% chance of high demand, with future cash flows of S80 million per year. There is a 40% chance of low demand, with cash flows of only $35 mililion per year. What is the expected NPV and CV of the project as is? Show the decision tree. (9 points) b) Now suppose the project cannot be delayed, but if Tropical Sweets implements the project there will exist an opportunity to rerun it if profitable, thus there exists a growth option. The firm will have an opportunity to replicate the original project at the end of its life, if it adds value only(for a total ot 6 years). What is total expected NPV and CV of the project with the growth option? Discount all cash flows at WACC. Show decision tree. (9 points) Assuming the variance of the project's return c) when the option expires is 14.00S, I have calculated values of N(d1) and N(d2) for and N(d2) 0.4599. you to use, which are as follows: N(d1)- 0.7079 Now calculate the value of the option to expand the project using Black and Scholes option pricing model. Show separate calculation for the value of P for using as an input in Black and Scholes option pricing model, and provide all other inputs to the model clearly marked (I do NOT need d1 and d2 calculation from you). Also, show the value of the project with the option to grow (where the value of the option is calculated with Black and Scholes approach, and the value of the project without the option is NPV from part a) of this problem, so show me the sum of the two). (7 points) F3 3 4 Problem 1: (25 points) Assume that you have just been hired as a financial analyst by Tropical Sweets Inc., a mid- sized California company that specializes in creating exotic candies from tropical fruits. The firm's CEO has asked you to prepare a brief on possible outcomes of the project the company is planning. a) Tropical Sweets is considering a project that will cost $120 million and will generate expected cash flows of $62 million per year for three years. The cost of capital for this type of project is 10% and the risk-free rate is 6%. After discussions with the marketing department, you learn that there is a 60% chance of high demand, with future cash flows of S80 million per year. There is a 40% chance of low demand, with cash flows of only $35 mililion per year. What is the expected NPV and CV of the project as is? Show the decision tree. (9 points) b) Now suppose the project cannot be delayed, but if Tropical Sweets implements the project there will exist an opportunity to rerun it if profitable, thus there exists a growth option. The firm will have an opportunity to replicate the original project at the end of its life, if it adds value only(for a total ot 6 years). What is total expected NPV and CV of the project with the growth option? Discount all cash flows at WACC. Show decision tree. (9 points) Assuming the variance of the project's return c) when the option expires is 14.00S, I have calculated values of N(d1) and N(d2) for and N(d2) 0.4599. you to use, which are as follows: N(d1)- 0.7079 Now calculate the value of the option to expand the project using Black and Scholes option pricing model. Show separate calculation for the value of P for using as an input in Black and Scholes option pricing model, and provide all other inputs to the model clearly marked (I do NOT need d1 and d2 calculation from you). Also, show the value of the project with the option to grow (where the value of the option is calculated with Black and Scholes approach, and the value of the project without the option is NPV from part a) of this problem, so show me the sum of the two). (7 points) F3 3 4
