Answered step by step
Verified Expert Solution
Question
1 Approved Answer
You have a potential project for which you want to establish the value of any possible real options. The project will have an initial cost
You have a potential project for which you want to establish the value of any possible real options. The project will have an initial cost of $86 million, which must be paid at the time of investment. You realize that the project has four possible cash flows starting in year 1 and continuing forever. First, there is a 21% chance of earning $1.78 million per year starting in year 1 . Second, there is a 28% chance of earning $7.33 million per year starting in year 1 . Third, there is a 15% chance the the project will earn $5.26 million per year. Fourth, there is a chance that the project will earn $2.57. These are the only four possibilities. In 4 year(s), you will be able to improve the quality of your manufacturing process to increase the net CFs from the project if you would like to. The cost of this will be $62 million, and the cash flows will increase beginning immediately when you make this investment (the CFs increase starting the same year that you pay the improvement cost) and will remain at the new level forever, if you choose to 'improve' the project. The 'improvement' will increase the project's cash flows by 120%. The risk-free rate and appropriate discount rate for the project is 5%. What is the value today of this option to 'improve'? Hint: you can treat this the same way you would an expansion option. Input your answer in millions of dollars, rounded to the nearest 0.001 (e.g. $19.056.129 would be entered as 19.056)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started