Question
Use the information below to answer the following three parts: Your management team has put together the following projections for a project in which your
Use the information below to answer the following three parts:
Your management team has put together the following projections for a project in which your company is interested implementing.
Demand | Probability | Annual Cash Flow |
High | 25% | $40 million |
Average | 50% | $30 million |
Low | 25% | $10 million |
Project's cost of capital |
| 9% |
Life of project |
| 3 years |
Required investment |
| $50 million |
Risk-free rate |
| 2% |
a) What is the expected net present value (NPV) of the project, ignoring any real option, using discounted cash flows (DCF)?
$79.00 million
$27.50 million
$19.61 million
$30.43 million
None of the above
b) What is the expected net present value (NPV) for the proposed project, considering an investment timing option to wait one year before implementation, according to the decision-tree procedure?
$16.51 million
$23.65 million
$21.70 million
$10.78 million
None of the above
c) Use the Black-Scholes model to estimate the call premium associated with the investment timing option to wait one year before implementing the proposed project. The real option has a strike price of $50, a variance of 20%, and a spot price of $40.
$4.19 million
$4.04 million
$23.65 million
$19.61 million
None of the above
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