You own a wholesale plumbing supply store. The store currently generates revenues of $1 million per year. Next year (the year to t=1), revenues will either decrease by 10% or increase by 5%, with equal probability, and then stay at that level as long as you operate the store. Other costs run $900,000 per year. Due to an agreement with the trade union, you have to keep this store operating for at least 3 years. Starting from the end of year 3 (t=3), you can sell the store for $500,000 anytime.

(i). What is the business worth today if the cost of capital is fixed at 10%? (8 marks)

(ii). Name the option embedded in your business. (2 marks)

(iii). What is the value of the real option embedded in your business?