Let the present value from production be equal to V = 100, and this value can...

Let the present value from production be equal to V = 100, and this value can move either up (with factor u = 1.4) or down (with factor d = 1/u) per period. Suppose that at t=3 management has the option to invest 130 million in order to double the value of production. The risk free rate is 2%.

What is the expanded present value of this production facility if management has the opportunity to expand at t = 3

Solutions

Expert Solution

Note: Since there is no mention of how many months are there in between 2 periods. I have assumed it to be 1 month and the total maturity as 3 months and the risk-free rate is assumed to be continuously compounding per annum.

Value of Option = $14.04 millions

All the values in the below image are in $ millions

Value of Call Option at Expiry = Maximum of (Stock price - strike price) or 0
Value of Call Option at Node = [(Probability of up move * Value of Option at the upper node) + (Probability of Down Move * Value of Option at the lower node)] * e-rf * dT
where dT = Time period between 2 periods

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

The present value of an annuity due is equal to the present value of an ordinary...

The present value of an annuity due is equal to the present value of an ordinary annuity times (1 + i). Select one: True False

Prove the following: Let V and W be vector spaces of equal (finite) dimension, and let...

Prove the following: Let V and W be vector spaces of equal (finite) dimension, and let T: V → W be linear. Then the following are equivalent. (a) T is one-to-one. (b) T is onto. (c) Rank(T) = dim(V).

Demonstrate that the marginal production cost is equal to the average production cost for the value...

Demonstrate that the marginal production cost is equal to the average production cost for the value of the output that minimizes the average production cost.

Let V be the 3-dimensional vector space of all polynomials of order less than or equal...

Let V be the 3-dimensional vector space of all polynomials of order less than or equal to 2 with real coeﬃcients. (a) Show that the function B: V ×V →R given by B(f,g) = f(−1)g(−1) + f(0)g(0) + f(1)g(1) is an inner product and write out its Gram matrix with respect to the basis (1,t,t2). DO NOT COPY YOUR SOLUTION FROM OTHER SOLUTIONS

Let V be a vector space and let U and W be subspaces of V ....

Let V be a vector space and let U and W be subspaces of V . Show that the sum U + W = {u + w : u ∈ U and w ∈ W} is a subspace of V .

Flip a fair coin 100 times. Let X equal the number of heads in the first...

Flip a fair coin 100 times. Let X equal the number of heads in the first 65 flips. Let Y equal the number of heads in the remaining 35 flips. (a) Find PX (x) and PY (y). (b) In a couple of sentences, explain whether X and Y are or are not independent? (c) Find PX,Y (x, y).

Let X equal the number of bad records in each 100 feet of a used computer...

Let X equal the number of bad records in each 100 feet of a used computer tape. Assume that X has a Poisson distribution with mean 2. Let W denote the number of feet before for the first bad record is found. Let Z denote the number of feet before for the second bad record is found. Let Y be the number of bad records in 50 feet. (a) What is P(2 ≤ Y ≤ 4) ? (b) What is...

Question