3e Chapter13_solutions.xls

# 3e Chapter13_solutions.xls - PROBLEM 13-1 By waiting to...

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PROBLEM 13-1 Solution Legend = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output By waiting to develop, the company retains the option to develop the higher NPV project--under certain scenarios, the high-density hotels will provide greater NPV, under other circumstances, low-density hotels will provide higher NPV. Of course, by waiting one loses the opportunity to gain a (dividend) yield that would accrue if one develops right away. The tradeoff is between the lost rents (profits) and the additional NPV that could be gained by taking the correct decision.

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PROBLEM 13-2 Given First Plant = Value giv Assume perpetual returns = Formula IRR 13.00% = Qualitati Initial investment \$ 600 million = Goal See Annual cash flow \$ 78 million = Crystal B = Crystal B Second Plant Initial investment \$ 550 million Additional Plants Initial investment \$ 500 million NPV Calculation Cost of capital 15.00% First plant \$ (80.00) million Second plant \$ (30.00) million Additional plant \$ (20.00) million Cost of capital 14.00% First plant \$ (42.86) million Second plant \$ 7.14 million Additional plant \$ 57.14 million Solution a. b. We are evaluating an investment strategy. The above analysis is based on expected cash flows, i.e., we assume that cash flows from the power plant are static. In reality, the NPV captures a range of scenarios. Over time, one would know which one of those scenarios (in terms of demand and price of electricity) will occur. Therefore, to analyze the option value of a power plant investment strategy, one has to estimate the volatility of the underlying uncertainty in project values, and build an equivalent binomial lattice that captures the evolution of PV of expected cash flows from power plants (as discussed in step 1 and step 2 of the chapter). Then, one should work backward and compute the value of the investment strategy, as described in step 3 and step 4 of the chapter. If we assume a cos NPV. There is insu money on the first On the other hand plants are all positi
c. The risk associated with the power plant strategy should be much higher. It involves setting aside a lot of capital for many more "bets" than investing in a single project.

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Solution Legend ven in problem a/Calculation/Analysis required ive analysis or Short answer required ek or Solver cell Ball Input Ball Output st of capital of 15%, all power plants will be negative ufficient reduction in costs over time to justify losing few power plants. if we assume a cost of capital of 14%, future power ive NPV.

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PROBLEM 13-3 Solution Legend = Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output There is no need to be skeptical about the use of strategic considerations. If one goes by the policy of investing in sure cash flows, all companies would be reduced to treasury bond portfolios. What is perhaps more critical is how one assesses risks and returns. While strategic considerations should
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