A project requires $150 million investment. If you invest today, the present value of future cash flow is worth $180 mil
Posted: Tue Nov 23, 2021 8:49 am
A project requires $150 million investment. If you
invest today, the present value of future cash flow is worth $180
million. You can wait for one year to observe the demand of the
market; however, you forgo the cashflow in year 1. Assume if the
demand is high, there will be a cash flow of $22 million in year 1
and the present value of future cash flows at the end of year 1 is
$220 million; if the demand is low, there will be a cash flow of
$12 million in year 1 and the present value of future cash flows at
the end of year 1 is $120 million. You need to use risk-neutral
valuation method to decide either invest today and start to collect
the cash flow or delay it for one year. Annual risk-free rate is
3%. Show your work to get full credit. Keep four
decimals.
(a). What’s the risk-neutral probability of high
demand?
(b). What’s the value of the timing
option?
(c). Do you want to wait for one year or invest today?
Why?
invest today, the present value of future cash flow is worth $180
million. You can wait for one year to observe the demand of the
market; however, you forgo the cashflow in year 1. Assume if the
demand is high, there will be a cash flow of $22 million in year 1
and the present value of future cash flows at the end of year 1 is
$220 million; if the demand is low, there will be a cash flow of
$12 million in year 1 and the present value of future cash flows at
the end of year 1 is $120 million. You need to use risk-neutral
valuation method to decide either invest today and start to collect
the cash flow or delay it for one year. Annual risk-free rate is
3%. Show your work to get full credit. Keep four
decimals.
(a). What’s the risk-neutral probability of high
demand?
(b). What’s the value of the timing
option?
(c). Do you want to wait for one year or invest today?
Why?