PQ6 - FINA 537 Equity Valuation Real Option Assignments for...

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FINA 537 Equity Valuation – Real Option Assignments for practice (No need to submit) 1. You must choose between two technologies for production of a Wankel-engine out-board motor. Technology A is designed to have lowest possible cost. But if the Wankel outboard doesn’t sell, this equipment will be worthless. Technology B uses standard machine tools. Labor costs are much higher, but the machinery can be sold for $10 million if the engine doesn’t sell. The payoffs (value at year 1) from producing outboard are as follows: Payoff from producing Outboard ($ millions) Technology A Technology B Bouyant demand $18.5 $18 Sluggish demand $8.5 $8 Assume the present value (value at year 0) of using technology A is $11.5 million in year 0. Risk free rate is 7%. a. What is the present value in year 0 if Technology B is used? (Hint: The payoffs with Technology B vs. A differ by a constant $.5 million.) b. Technology B allows abandonment in year 1 for $10 million salvage value. Calculate abandon option value? Which technology is better considering this
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PQ6 - FINA 537 Equity Valuation Real Option Assignments for...

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