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Return to the Sport Hotel example from class and detailed in Chapter 9. Suppose that everything stays the same as was presented in the original
Return to the Sport Hotel example from class and detailed in Chapter 9. Suppose that everything stays the same as was presented in the original problem with the exception of one thing: the value of the hotel, should the city be awarded the franchise, is not $8 million but instead is $5.70 million. Using this one new value, a probability of being awarded the franchise of 50%, and incorporating the real option to abandon, what would the NPV be at the decision node B on the decision tree?
* In fact, any probability above 25%, even 26%, leads to acceptance. (17) Solving a Real Option Analysis Using Decision Trees: The Sportne has two decision points. The first is whether or not to start the project, and second is whether to abandon the project after the ner to abandon the project after the first year. In the decision tree, although time is illustrated moving from the left to the right side of the tree, solve the project NPV from the other direction. This is known as backward induction. The first step is to determine the cash flows at C and D: franchise is granted -> complete hotel gives NPV of +$3 million C B DC abandon project gives NPV of -S1 million Do not build ($0) The next step is to determine the value of the project at node B. Since B is an information node, the value at node B is based on probabilities and uncertainty. If the paths are equally likely (that is, a 50% probability of each path) the node B value is: * In fact, any probability above 25%, even 26%, leads to acceptance. (17) Solving a Real Option Analysis Using Decision Trees: The Sportne has two decision points. The first is whether or not to start the project, and second is whether to abandon the project after the ner to abandon the project after the first year. In the decision tree, although time is illustrated moving from the left to the right side of the tree, solve the project NPV from the other direction. This is known as backward induction. The first step is to determine the cash flows at C and D: franchise is granted -> complete hotel gives NPV of +$3 million C B DC abandon project gives NPV of -S1 million Do not build ($0) The next step is to determine the value of the project at node B. Since B is an information node, the value at node B is based on probabilities and uncertainty. If the paths are equally likely (that is, a 50% probability of each path) the node B value isStep by Step Solution
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