Exercise 3.pdf - DERIVATIVES AND RISK MANAGEMENT 2018 Exercise 3 Deadline February 1 2018 at 16.00 1 You are managing a firm where the assets NPV of

Exercise 3.pdf - DERIVATIVES AND RISK MANAGEMENT 2018...

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DERIVATIVES AND RISK MANAGEMENT 2018 Exercise 3 Deadline: February 1, 2018 at 16.00 1. You are managing a firm where the asset’s NPV of future cash flows today is A C100m. Today you are facing the following problem: You have a certain equipment which requires maintenance. You can invest in maintenance of this equipment for A C3m. You have already bought a replacement for this equipment which arrives in 2 years time and without maintenance this equipment is junk after two years. However, if you expend on maintenance, you may be able to salvage some value from resale of this equiment. Typically resale markets are very reputation based. The resale value of a used eqipment from a big firm is valued more. In other words, if your firm is worth more you get more value for your equipment. Let’s assume in this case, you find that if your firm is worth more than A C75m when you sell, then you get a resale value of A C5m. Else, you get only A C1m from resale.
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