Question

Background information for the rest questions:

You own a small manufacturing plant that currently generates revenues of $2 million per year. Next year, based upon a decision on a long-term government contract, your revenues will either increase by 20% or decrease by 25%, with equal probability, and stay at that level as long as you operate the plant. Other costs run $1.6 million dollars per year. You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.

Given the embedded option to sell the plant, the value of your plant will be closest to:

A) $5.0 million

B) $4.0 million

C) $6.5 million

Assume that it will cost you $1 million to shut down the plant, but you are able to sell the plant for $5 million at any time. The value of the option to sell the plant will be closest to:

A) $3.0 million

B) $6.0 million

C) $5.0 million

D) $0.5 million

D) $8.0 million

Answer 1

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