61.
|
You sold one call option contract with a strike price of $55 when the option was quoted at $0.80. The option expires today when the value of the underlying stock is $53.70. Ignoring trading costs and taxes, what is the net profit or loss on this investment?
Total profit = $0.80 × 100 × 1 = $80. The call finished out-of-the-money.
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Call payoff |
62.
|
You sold three $35 call option contracts at a quoted price of $1.40. What is your net profit or loss on this investment if the price of the underlying asset is $38.10 on the option expiration date?
Total loss = ($1.40 + $35 - $38.10) × 100 × 3 = -$510
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Call payoff |
63.
|
You wrote eight call option contracts with a strike price of $42.50 at a call price of $1.35 per share. What is your net gain or loss on this investment if the price of the underlying stock is $40.30 per share on the option expiration date?
Net profit = $1.35 × 100 × 8 = $1,080. The call finished out-of-the-money.
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Call payoff |
64.
|
The market price of Southern Press stock has been relatively volatile and you think this volatility will continue for a couple more months. Thus, you decide to purchase a two-month European call option on this stock with a strike price of $45 and an option price of $2.00. You also purchase a two-month European put option on the stock with a strike price of $45 and an option price of $0.30. What will be your net profit or loss on these option positions if the stock price is $48 on the day the options expire? Ignore trading costs and taxes.
Net profit = [(-$2.00 + $48 - $45) × 100] + [-$0.30 × 100] = $70
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Option payoffs |
65.
|
Several rumors concerning Value Rite stock are causing the market price of the stock to be quite volatile. Given this situation, you decide to buy both a one-month European $25 put and a one-month European $25 call on this stock. The call price per share is $0.60 and the put price per share is $2.10. What will be your net profit or loss on these option positions if the stock price is $18 on the day the options expire? Ignore trading costs and taxes.
Net profit = [-$0.60 × 100] + [(-$2.10 + $25 - $18) × 100] = $430
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Option payoffs |
66.
|
Three months ago, Central Supply stock was selling for $51.40 a share. At that time, you purchased five put options on the stock with a strike price of $52 per share and an option price of $0.60 per share. The option expires today when the value of the stock is $42.70 per share. What is your net profit or loss on this investment? Ignore trading costs and taxes.
Net profit = (-$0.60 - $42.70 + $52) × 100 × 5 = $4,350
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Put payoff |
67.
|
You wrote two put options on Xylo stock with an exercise price of $30 per share and an option price of $1.05 per share. Today, the contracts expire and the stock is selling for $31.15 a share. What is your net profit or loss on this investment? Ignore trading costs and taxes.
Net profit = $1.05 × 100 × 2 = $210. The put finished out of the money.
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Put payoff |
68.
|
You sold ten put contracts on Cross Town Bank stock at an option price per share of $0.85. The options have an exercise price of $39 per share. The options were exercised today when the stock price was $34 a share. What is your net profit or loss on this investment assuming that you closed out your positions at a stock price of $34? Ignore transaction costs and taxes.
Net loss = ($0.85 - $39 + $34) × 100 × 10 = -$4,150
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.1 Topic: Put payoff |
69.
|
You own eight call option contracts on Swift Water Tours stock with a strike price of $15. When you purchased the shares the option price was $0.30 and the stock price was $15.25. What is the total intrinsic value of these options if the stock is currently selling for $16.08 a share?
Intrinsic value = ($16.08 - $15) × 100 × 8 = $864
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Intrinsic value |
70.
|
You recently purchased three put option contracts on Guillepsi stock with an exercise price of $42.50. What is the total intrinsic value of these contracts if the stock is currently selling for $45 a share?
The intrinsic value is equal to zero because the puts are out-of-the-money.
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Intrinsic value |
71.
|
Last week, you purchased a call option on Edgewater stock with a strike price of $40. The stock price was $39.80 and the option price was $0.45 at that time. What is the intrinsic value per share if the stock is currently priced at $39.10?
The intrinsic value is zero because the call is currently out-of-the-money.
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Intrinsic value |
72.
|
Three weeks ago, you purchased a June $30 put option on Leeper Metals stock at an option price of $1.80. The market price of the stock three weeks ago was $30.60. Today, the stock is selling at $27.50 a share. What is the intrinsic value of your put contract?
Contract intrinsic value = ($30 - $27.50) × 100 = $250
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Intrinsic value |
73.
|
This morning, you purchased a call option on Schoolhouse Supply Co. stock that expires in one year. The exercise price is $40. The current price of the stock is $43.40 and the risk-free rate of return is 3.6 percent. Assume the option will finish in the money. What is the current value of the call option?
C0 = $43.40 - [$40/(1 + 0.036)] = $4.79
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-01 The basics of call and put options and how to calculate their payoffs and profits. Section: 24.2 Topic: Call value |
74.
|
You currently own a one-year call option on Rail Company, Inc., stock. The current stock price is $52.75 and the risk-free rate of return is 4.25 percent. Your option has a strike price of $50 and you assume the option will finish in the money. What is the current value of your call option?
C0 = $52.75 - [$50/(1 + 0.0425)] = $4.79
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Call value |
75.
|
The common stock of Hazelton Refiners is selling for $72.30 a share. U.S. Treasury bills are currently yielding 4.8 percent. What is the current value of a one-year call option on this stock if the exercise price is $70 and you assume the option will finish in the money?
C0 = $72.30 - [$70/(1 + 0.048)] = $5.51
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Call value |
76.
|
The common stock of Westover Foods is currently priced at $28.80 a share. One year from now, the stock price is expected to be either $25 or $30 a share. The risk-free rate of return is 4.2 percent. What is the current value of one call option on this stock if the exercise price is $27.50?
Number of options needed = ($30 - $25)/(2.50 - 0) = 2
$28.80 = 2 C0 + [$25/(1 + 0.042)]; C0 = $2.40 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.3 Topic: Call value |
77.
|
You own one call option with an exercise price of $40 on S'more Good stock. The stock is currently selling for $41 a share but is expected to sell for either $37 or $43 a share in one year. The risk-free rate of return is 4.25 percent and the inflation rate is 3.6 percent. What is the current call option price if the option expires one year from now?
Number of options needed = ($43 - $37)/(3 - 0) = 2
$41 = 2C0 + [$37/(1 + 0.0425)]; C0 = $2.75 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.3 Topic: Call value |
78.
|
The assets of Uptown Stores are currently worth $138,000. These assets are expected to be worth either $120,000 or $150,000 one year from now. The company has a pure discount bond outstanding with a $130,000 face value and a maturity date of one year. The risk-free rate is 4.3 percent. What is the value of the equity in this firm?
Number of options needed = ($150,000 - $120,000)/($20,000 - $0) = 1.5
$138,000 = 1.5C0 + ($120,000/(1 + 0.043); C0 = $15,298 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-04 How to value a firm's equity as an option on the firm's assets. Section: 24.5 Topic: Equity as a call option |
79.
|
Electronic Importers has a pure discount bond with a face value of $25,000 that matures in one year. The risk-free rate of return is 3.8 percent. The assets of the business are expected to be worth either $23,000 or $35,000 in one year. Currently, these assets are worth $27,500. What is the current value of the bond?
Number of options needed = ($35,000 - $23,000)/($10,000 - $0) = 1.2
$27,500 = 1.2C0 + ($23,000/(1 + 0.038)); C0 = $4,451.67 Value of debt = $27,500 - $4,451.67 = $23,048 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-04 How to value a firm's equity as an option on the firm's assets. Section: 24.5 Topic: Equity as a call option |
80.
|
The Glass House has total assets currently valued at $17,300. These assets are expected to increase in value to either $18,000 or $21,000 by next year. The company has a pure discount bond outstanding with a face value of $20,000. This bond matures in one year. Currently, U.S. Treasury bills are yielding 5.4 percent. What is the value of the equity in this firm?
Number of options needed = ($21,000 - $18,000)/($1,000 - $0) = 3
$17,300 = 3C0 + ($18,000/(1 + 0.054)); C0 = $74.07 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-04 How to value a firm's equity as an option on the firm's assets. Section: 24.5 Topic: Equity as a call option |
81.
|
You are considering a project that has been assigned a discount rate of 14 percent. If you start the project today, you will incur an initial cost of $8,500 and will receive cash inflows of $5,550 a year for two years. If you wait one year to start the project, the initial cost will rise to $9,200 and the cash flows will increase to $5,800 a year for two years. What is the value of the option to wait?
Value of option to wait = $307.57 - $638.97 = -$331.40 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to wait |
82.
|
Southern Shores is considering a project that has an initial cost today of $13,000. The project has a two-year life with cash inflows of $7,500 a year. Should the firm opt to wait one year to commence this project, the initial cost will increase by 5 percent and the cash inflows will increase to $8,500 a year. What is the value of the option to wait if the applicable discount rate is 12 percent?
Value of option to wait = $638.78 - (-$324.62) = $963.40 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to wait |
83.
|
Western Industrial Products is considering a project with a four-year life and an initial cost of $212,000. The discount rate for the project is 16 percent. The firm expects to sell 9,600 units on the last day of each year. The cash flow per unit is $50. The firm will have the option to abandon this project at the end of year one (after year one's sales) at which time the project's assets could be sold for an estimated $125,000. The firm should abandon the project at the end of year one if the expected level of annual sales, starting with year 2, falls to _____ units or less. Ignore taxes.
|
AACSB: Analytic
Blooms: Analyze Difficulty: 2 Medium Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to abandon |
84.
|
Dressler Technologies is considering a project with a 3-year life and an initial cost of $87,000. The discount rate for the project is 14.5 percent. The firm expects to sell 1,300 units on the last day of each year. The cash flow per unit is $32. The firm will have the option to abandon this project at the end two years (after year 2 sales) at which time the project's assets could be sold for an estimated $30,000. The firm's managers are interested in knowing how the project will perform if the sales forecast for year 3 of the project is revised such that there is a 50/50 chance that the sales will be either 1,000 or 1,400 units a year. What is the net present value of this project at time zero given the current sales forecasts?
Level to abandon = $30,000 = $32Q/1.145; Q = 1,073.44 units
At 1,000 units, you will abandon the project and receive $30,000 at the end of year 2. At 1,400 units, you will continue the project and the project will have a value at the end of year 2 of: NPVEnd of year 2 = (1,400 × $32)/1.145 = $39,126.64 The NPV of this project today is: |
AACSB: Analytic
Blooms: Analyze Difficulty: 3 Hard Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to abandon |
85.
|
Patience is reviewing a project with projected sales of 4,200 units a year, a cash flow of $28 a unit, and a four-year project life. Assume all operating cash flows occur on the last day of each year. The initial cost of the project is $247,000. The relevant discount rate is 13 percent. Patience has the option to abandon the project after two years at which time she feels she could sell the project's assets for $110,000. At what level of annual sales, starting in year 3, should she be willing to abandon this project?
|
AACSB: Analytic
Blooms: Analyze Difficulty: 2 Medium Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to abandon |
86.
|
You own a convertible bond with a face value of $1,000 and a market value of $1,034. The bond can be converted into 16 shares of stock. What is the conversion price?
Conversion price = $1,000/16 = $62.50
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
87.
|
You own nine convertible bonds. These bonds have a 7 percent coupon, a $1,000 face value, and mature in 6 years. The bonds are convertible into shares of common stock at a conversion price of $25. How many shares of stock will you receive if you convert all of your bonds?
Number of shares = ($1,000/$25) × 9 = 360 shares
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
88.
|
A convertible bond has a face value of $5,000 and a conversion price of $80. The bond has a 6 percent coupon, pays interest semi-annually, and matures in 12 years. Similar bonds are yielding 7.5 percent. The current price of the stock is $42 per share. What is the conversion value of this bond?
Conversion value = ($5,000/$80) × $42 = $2,625
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
89.
|
A convertible bond has a face value of $1,000 and a conversion price of $12.50. The bond has a 6 percent coupon, pays interest semi-annually, and matures in 12 years. Similar bonds are yielding 9 percent. The current price of the stock is $13.40 per share. What is the straight bond value?
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
90.
|
Kurt owns a convertible bond that matures in three years. The bond has an 8 percent coupon and pays interest semi-annually. The face value of the bond is $1,000 and the conversion price is $25. Similar bonds have a market return of 9.25 percent. The current price of the stock is $26.50 per share. What is the straight bond value?
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
91.
|
Lucinda owns a convertible bond that matures in six years. The bond has a 9 percent coupon and pays interest annually. The face value of the bond is $1,000 and the conversion price is $22. Similar bonds have a market return of 8.75 percent. The current price of the stock is $21.60 per share. What is the conversion value of this bond?
Conversion value = ($1,000/$22) × $21.60 = $981.82
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Convertible bonds |
92.
|
T-bills currently yield 6.3 percent. Stock in Pinta Manufacturing is currently selling for $46 per share. There is no possibility that the stock will be worth less than $39 per share in one year. What is the value of a call option on this stock if the exercise price is $24 per share?
C0 = $46 - [$24/(1 + 0.063)] = $23.42
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy EOC: 24-1 Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.2 Topic: Option value |
93.
|
The price of Time Squared Corp. stock will be either $80 or $95 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 6 percent and the current price of Time Squared Corp. stock is $85. What is the value of a call option if the exercise price is $75 per share?
C0 = $85 - [$75/(1 + 0.06)] = $14.25
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy EOC: 24-4 Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.3 Topic: Option value |
94.
|
The price of Dimension, Inc. stock will be either $65 or $87 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. Suppose the current price of Dimension stock is $70. What is the value of the call option if the exercise price is $70 per share?
$70 = [($87 - $65)/($87 - $70)]C0 + $65/(1 + 0.05); C0 = $6.26
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy EOC: 24-5 Learning Objective: 24-02 The factors that affect option values and how to price call and put options using no arbitrage conditions. Section: 24.3 Topic: Option value |
95.
|
Rackin Pinion Corporation's assets are currently worth $1,260. In one year, they will be worth either $1,200 of $1,610. The risk-free interest rate is 5 percent. Suppose Rackin Pinion has an outstanding debt issue with a face value of $1,200. What is the current value of the firm's debt?
E0 = $1,260 - [$1,200/(1 + 0.05)] = $117.14
D0 = $1,260 - $117.14 = $1,142.86 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy EOC: 24-7 Learning Objective: 24-04 How to value a firm's equity as an option on the firm's assets. Section: 24.5 Topic: Equity as an option |
96.
|
Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of Buckeye's assets is currently $1,350. Jim Tressell, the CEO, believes that the assets in the firm will be worth either $600 or $1,700 in a year. The going rate on one-year T-bills is 6 percent. What is the current value of the firm's debt?
$1,350 = [($1,700 - $600)/($1,700 - $1,000)] E0 + [$600/(1 + 0.06)] = $498.89
D0 = $1,200 - $498.89 = $851.11 |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy EOC: 24-8 Learning Objective: 24-04 How to value a firm's equity as an option on the firm's assets. Section: 24.5 Topic: Equity as an option |
97.
|
A $1,000 convertible debenture has a conversion price for common stock of $85 per share. The common stock is selling at $92 a share. What is the conversion value of this bond?
Conversion value = ($1,000/$85)($92) = $1,082.35
|
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy EOC: 24-9 Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Conversion value |
98.
|
A bond with 10 detachable warrants has just been offered for sale at $1,000. The bond matures in 12 years and has an annual coupon of $80. Each warrant gives the owner the right to purchase two shares of stock in the company at $14 per share. Ordinary bonds (with no warrants) of similar quality are priced to yield 11 percent. What is the value of one warrant?
Total warrant value = $1,000 - $805.23 = $194.77 Price per warrant = $194.77/10 = $19.48 |
AACSB: Analytic
Blooms: Apply Difficulty: 1 Easy EOC: 24-12 Learning Objective: 24-06 The basics of convertible bonds and warrants and how to value them. Section: 24.7 Topic: Warrant values |
99.
|
Your company is deciding when to invest in a new machine. The new machine will increase cash flow by $240,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $1,200,000. The cost of the machine will decline by $120,000 per year until it reaches $720,000, where it will remain. Your required return is 8 percent. In which year should you purchase the machine?
The company should purchase the machine today when the NPV is the highest. |
AACSB: Analytic
Blooms: Analyze Difficulty: 1 Easy EOC: 24-13 Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Option to wait |
100.
|
We are examining a new project. We expect to sell 9,500 units per year at $48 net cash flow apiece for the next 20 years. In other words, the annual operating cash flow is projected to be $45 × 9,000 = $405,000. The relevant discount rate is 14 percent, and the initial investment required is $1,730,000. After the first year, the project can be dismantled and sold for $1,350,000. If expected sales are revised based on the first year's performance, it would make sense to abandon the investment if the sales are less than which of the following number of units?
$1,350,000 = ($48)(Q)(PVIFA14%, 19); Q = 4,294 units
Abandon the project if Q < 4,294 units because the NPV of abandoning the project is greater than the NPV of the future cash flows. |
AACSB: Analytic
Blooms: Analyze Difficulty: 2 Medium EOC: 24-14 Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Abandonment value |
101.
|
We are examining a new project. We expect to sell 8,000 units per year at $80 net cash flow apiece for the next 15 years. In other words, the annual operating cash flow is projected to be $80 × 8,000 = $640,000. The relevant discount rate is 16 percent, and the initial investment required is $2,740,000. The project can be dismantled after the first year and sold for $2,130,000. Suppose you think it is likely that expected sales will be revised upward to 9,600 units if the first year is a success and revised downward to 3,000 units if the first year is not a success. Suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold. Naturally, expansion would be desirable only if the project is a success. This implies that if the project is a success, projected sales after expansion will be 19,200. Assume that success and failure are equally likely. Note that abandonment is still an option if the project is a failure. What is the value of the option to expand?
The gain from the option to expand is the present value of the cash flows from the additional units sold, so:
Gain from option to expand = $80(9,600)(PVIFA16%, 14) = $4,199,062.39 We need to find the value of the option to expand times the likelihood of expansion. We also need to find the value of the option to expand today, so: Option value = (0.50)($4,199,062.39)/1.16 = $1,809,941 |
AACSB: Analytic
Blooms: Evaluate Difficulty: 2 Medium EOC: 24-16 Learning Objective: 24-05 How option valuation can be used to evaluate capital budgeting projects; including timing options; the option to expand; the option to abandon; and the option to contract. Section: 24.6 Topic: Abandonment and expansion |
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