Question 2: Real Options Teslo Inc., is an Amcrican automotive company that specializes in electric car manufacturing. On 22 November 2019, Teslo Inc, unveiled the "Cybertruck", its first pickup truck ever. The Cybertnuck has a futuristic look and comes with some cool features such as a frame made of a heavy-duty stainless steel, has armored glass and is fully electric. The company is considering selling the Cybertruck in Europe. While the truck has received a lot of media attention in the United States because of its unconventional design, it is not elear whether there will be a lot of demand for this product in Europe, Teslo Ine.'s marketing department has come up with the following data (in millions of dollars), for the upcoming four years: - t=0. The marketing manager undertakes a study that would give the firm a better idea of demand for the product. The study costs $1 million. - t=1. If the market research study indicates good potential, the firm would spend $2 million in setting up a logistics infrastructure at t=1 to bring to the market in period 2 . The best estimate is that there is a 60% probability that the market research study would indicate good potential and thus that further work would be done, and a 40% probability that the outlook would look bad and the project would be abandoned. - t=2. Once the pickup truck has been brought to the market, there is a 70 i probability that it will be well received by the market and a 30% probability that market demand will be moderate. If the truek is well received by the market, the incremental FCFs to Teslo Inc, will be 56 million for the upcoming three years or Teslo Inc, will have incremental FCFs of $2 million for the upcoming three yean if the demand fums out to be moderate; - t=4. After year four, Teslo Inc, will discontinue the project, regardless of the level of demand. Since the project is considered to be quite risky, a cost of capital of toss is used. The risk-free rate is cqual to 0tik a. Which type of real option is embedided in Teslo's project? Explain. b. What is the NPY of Teslo low.'s peoject (this includes the embedded value of the strategen real optionsy? a. Illustrate graphically how leverage impacts the cost of equity, cost of debt, and WACC under Modigliani \& Miller's two propositions. Consider both a situation without and with corporate taxes. Explain. Dabney Electronies currently has no debt. Its operating income is $20 million and its tax rate is 40 percent. It pays out all of its net income as dividends and has a zero growth rate. The current stock price is $40 per share, and it has 2.5 million shares of stock outstanding. If it moves to a capital structure that has 40 percent debt and 60 percent equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10 percent. b. What would its stock price be if it changes to the new capital structure
