Growth Option: Option Analysis Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for Unive
Posted: Wed Jul 06, 2022 6:43 pm
Growth Option: Option Analysis
Fethe's Funny Hats is considering selling trademarked,orange-haired curly wigs for University of Tennessee footballgames. The purchase cost for a 2-year franchise to sell the wigs is$20,000. If demand is good (40% probability), then the net cashflows will be $25,000 per year for 2 years. If demand is bad (60%probability), then the net cash flows will be $5,000 per year for 2years. Fethe's cost of capital is 10%.
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If Fethe makes the investment today, then it will have theoption to renew the franchise fee for 2 more years at the end ofYear 2 for an additional payment of $20,000. In this case, the cashflows that occurred in Years 1 and 2 will be repeated (so if demandwas good in Years 1 and 2, it will continue to be good in Years 3and 4). Use the Black-Scholes model to estimate the value of theoption. Assume the variance of the project's rate of return is0.2162 and that the risk-free rate is 7%. Do not round intermediatecalculations. Round your answers to the nearest dollar.
Use computer software packages, such as Minitab or Excel, tosolve this problem.
Value of the growth option: $
Value of the entire project: $
Fethe's Funny Hats is considering selling trademarked,orange-haired curly wigs for University of Tennessee footballgames. The purchase cost for a 2-year franchise to sell the wigs is$20,000. If demand is good (40% probability), then the net cashflows will be $25,000 per year for 2 years. If demand is bad (60%probability), then the net cash flows will be $5,000 per year for 2years. Fethe's cost of capital is 10%.
$
If Fethe makes the investment today, then it will have theoption to renew the franchise fee for 2 more years at the end ofYear 2 for an additional payment of $20,000. In this case, the cashflows that occurred in Years 1 and 2 will be repeated (so if demandwas good in Years 1 and 2, it will continue to be good in Years 3and 4). Use the Black-Scholes model to estimate the value of theoption. Assume the variance of the project's rate of return is0.2162 and that the risk-free rate is 7%. Do not round intermediatecalculations. Round your answers to the nearest dollar.
Use computer software packages, such as Minitab or Excel, tosolve this problem.
Value of the growth option: $
Value of the entire project: $