Answered step by step
Verified Expert Solution
Link Copied!

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

image text in transcribed
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

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Investment Risk Management

Authors: Yen Yee Chong

1st Edition

0470849517, 9780470849514

More Books

Students also viewed these Finance questions

Question

Convert 2500 cubic feet per minute to cubic meters per second.

Answered: 1 week ago

Question

2 What can organisations do to improve employee utilisation?

Answered: 1 week ago

Question

4 When is it a good idea to use the external supply of labour?

Answered: 1 week ago

Question

3. What would you do now if you were Mel Fisher?

Answered: 1 week ago