Zuti has a capital investment project that could start immediately. The project will require a machine costing $2.4 million. The total discounted value now of the cash inflows from the project will be either $2.6 million or $1.9 million with equal probability. The risk-free rate is 3%. Instead of starting immediately the project could be delayed until one year from now to gain more market information. Its total discounted cash inflows at that time will be known as either $2.6 million, or $1.9 million, with certainty. (i) What is the present value of the option to delay? (ii) The supplier of the machine has offered to deliver it (if required) in one year's time at a price of only $2 million, if Zuti pays a non-refundable deposit now. What is the maximum the firm should pay as a deposit now? What type of real option does this represent for Zuti? Identify the specific components of the option contract.

Zuti has a capital investment project that could start immediately. The project will require a machine costing $2.4 million. The total discounted value now of the cash inflows from the project will be either $2.6 million or $1.9 million with equal probability. The risk-free rate is 3%. Instead of starting immediately the project could be delayed until one year from now to gain more market information. Its total discounted cash inflows at that time will be known as either $2.6 million, or $1.9 million, with certainty. (i) What is the present value of the option to delay? (ii) The supplier of the machine has offered to deliver it (if required) in one year's time at a price of only $2 million, if Zuti pays a non-refundable deposit now. What is the maximum the firm should pay as a deposit now? What type of real option does this represent for Zuti? Identify the specific components of the option contract.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter14: Real Options

Section: Chapter Questions

Problem 3MC: Tropical Sweets is considering a project that will cost $70 million and will generate expected cash...

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