PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 22, Problem 16PS
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To determine: The value of call.
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You are considering the purchase of real estate that will provide perpetual income that should average $65,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 6%, and the expected market return is 10.0%.
You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate. Which option has a higher present value? Show the calculations of the present value for both options.
On May 25, 2018 you purchased an option which will allow you to sell a commercial building on August 14, 2022 for $42 million. Your current estimate of the value of the commercial building is $38 million. The annual volatility for the change in the commercial building’s value is 57% and the risk-free rate is 6%.
What type of option is this?
Calculate the value of the option to sell the commercial building.
Please show work in excel and equations/questions used.
Chapter 22 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 22 - Real options Respond to the following comments. a....Ch. 22 - Prob. 2PSCh. 22 - Real options True or false? a. Real-options...Ch. 22 - Prob. 4PSCh. 22 - Real options Describe each of the following...Ch. 22 - Expansion options Look again at the valuation in...Ch. 22 - Expansion options Look again at Table 22.2. How...Ch. 22 - Prob. 8PSCh. 22 - Timing options Look back at the Malted Herring...Ch. 22 - Prob. 10PS
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- Dog You are considering the purchase of real estate that will provide perpetual income that should average$61,000 per year. How much will you pay for the property if you believe its market risk is the same as themarket portfolio%u2019s? The T-bill rate is 3%, and the expected market return is 12.5%.arrow_forwardThe risk free interest rate is 150 basis points. The market is assigning a risk premium of 300 basis points to upscale garden-style apartment complexes located in high growth southern United States cities. You own such an apartment complex that produced cashflow last year for investor returns and debt payments of $1.25 million. Your investors want to sell because they believe cap rates will increase in the next year. What selling price would you recommend for the property? Question 12 options: $27.8 million $41.7 million $83.3 million $23.2 millionarrow_forward3. An investor plans to buy a property. She has two options for loans: (1) Loan balance=10, maturity=10 years, interest rate=1%; (2) Loan balance=20, maturity=10 years, interest rate=2%. The incremental (or marginal) borrowing cost by choosing the option (2), instead of the option (1), is approximately x%. Calculate the value of x.arrow_forward
- On May 25, 2018 you purchased an option which will allow you to sell a commercial building on August 14, 2022 for $42 million. Your current estimate of the value of the commercial building is $38 million. The annual volatility for the change in the commercial building’s value is 57% and the risk-free rate is 6%. a. What type of option is this? b. Calculate the value of the option to sell the commercial building. Please show work using excelarrow_forwardYou have the opportunity to make an investment that costs $1.000,000. If you make this investment now, you will receive $250,000 one year from today, $200,000, $150,000 and $ 400,000 two and three years from today, respectively. The appropriate discount rate for thisinvestment is 11 percent. .a. Should you make the investment?b. What is the net present value (NPV) of this opportunity?c. If the discount rate is 10 percent, should you invest? Compute the NPV to support youranswer.arrow_forward1. Option Pricing A. Suppose an investor offers to sell you a call option for a share in Baroque Inc. (a housing construction firm). The offer is for a one-year European call option that has an exercise price of $130. Baroque's stock price is currently selling for $120, and over the coming year the price will either rise to $160 or fall to $110. Also, the one- year rate of interest is 10 percent. If the investor offers to sell the option for $10, would you go for broke and buy a call option for Baroque? (Sorry for the bad pun.) Please explain carefully. B. Sketch a graph of an investor's payoff as a function of future stock price if the investor holds both a put option with an exercise price of $130 and a share of Baroque stock.arrow_forward
- What is the value of the abandonment option (in millions), in the question below? Round your answer to two decimal places... Sunshine Smoothies Company (SSC) manufactures and distributes smoothies.It is considering the introduction of a "weight loss" smoothie.The project would require a $4 million investment outlay today (t = 0).The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers.There is a 30% chance that demand will be good, in which case the project will produce after-tax cash flows of $2 million at the end of each of the next 3 years.There is a 70% chance that demand will be poor, in which case the after-tax cash flows will be $1 million for 3 years.The project is riskier than the firm's other projects, so it has a WACC of 12%.The firm will know if the project is successful after receiving first year's cash flows.After receiving the first year's cash flows it will have the option to abandon the project.If the firm decides to…arrow_forwardSuppose you buy a one-year European call option on Apple with an exercise price of $100 and sell a one-year put option with the same exercise price. The current stock price is $100, and the interest rate is 10%. Draw a position diagram showing the payoffs from your investments. How much will the combined position cost you?arrow_forwardYou are considering an investment that will pay you $1,200 in two year, $2,400 in three years and $3,600 in four years. If investors require a return of 8%, what price should it sell for? Question 2 options: 5,580 4,217 3,908 6,783 4,816arrow_forward
- Question: Gasworks, Inc., has been approached to sell up to 2.4 million gallons of gasoline in three months at a price of $2.40 per gallon. Gasoline is currently selling on the wholesale market at $2.20 per gallon and has a standard deviation of 58 percent. If the risk-free rate is 3.5 percent per year, what is the value of this option? Use the two-state model to value the real option. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)arrow_forwardGiven the following variables: S = $50, E = $45, T = 1 year, r = 2 %, and P = $5; if the call option is selling for $11 (C = $11), what arbitrage opportunity exists? Outline the strategy and the profit to be realized.arrow_forwardYou are considering investing in a real estate project. Your one ownership unit would cost $ 30,000. The project is expected to generate annual cash flows for you of $4,500 in year 1, $5.000 in years 2-5. $8,000 in year 6 and $19,000 in year 7. With a discount rate of 5.0%, what is the net present value (NPV) of this investment? Should you invest in this deal? Whyor why not? Please provide the proper keystrokes for the BAIIPlus and the Qualifier Plus IIIfx calculators. Thank you!arrow_forward
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