Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows. What is the value of the option to sell the plant? A. $0.5 million B. $0.75 million C. $1.25 million D. $1.5 million
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows. What is the value of the option to sell the plant? A. $0.5 million B. $0.75 million C. $1.25 million D. $1.5 million
Chapter11: Cash Flow Estimation And Risk Analysis
Section: Chapter Questions
Problem 8P
Related questions
Question
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of
$2 million per year. Based on uncertainty surrounding its long term government
contract, next year’s revenue will either increase by 20% or decrease by 25%, with
equal probability and then stay the same forever. Mosaic projected that the costs will
be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant
for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash
flows.
What is the value of the option to sell the plant?
A. $0.5 million
B. $0.75 million
C. $1.25 million
D. $1.5 million
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 2 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Managerial Accounting: The Cornerstone of Busines…
Accounting
ISBN:
9781337115773
Author:
Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Publisher:
Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
Managerial Accounting: The Cornerstone of Busines…
Accounting
ISBN:
9781337115773
Author:
Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Publisher:
Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
Cornerstones of Cost Management (Cornerstones Ser…
Accounting
ISBN:
9781305970663
Author:
Don R. Hansen, Maryanne M. Mowen
Publisher:
Cengage Learning
Principles of Accounting Volume 2
Accounting
ISBN:
9781947172609
Author:
OpenStax
Publisher:
OpenStax College