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fm13 9 - = $2.514 million 13-8 P = PV as of time zero of...

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Answers and Solutions: 13 - 9 13-7 P = PV of all expected future cash flows if project is delayed. From Problem 13-1 we know that PV @ Year 2 of Low CF Scenario is $6.974 and PV @ Year 2 of High CF Scenario is $13.313. So the PV is: P = [0.1(6.974)+ 0.9(13.313] / 1.10 2 = $10.479. X = $9. t = 2. r RF = 0.06. σ 2 = 0.0111. d 1 = ln[10.479/9] + [0.06 + .5(.0111)](2) = 1.9010 (.0111) 0.5 (2) 0.5 d 2 = 1.9010 - (.0111) 0.5 (2) 0.5 = 1.7520 From Excel function NORMSDIST, or approximated from the table in Appendix A: N(d 1 ) = 0.9713 N(d 2 ) = 0.9601 Using the Black-Scholes Option Pricing Model, you calculate the option’s value as: V = P[N(d 1 )] - t r RF Xe [N(d 2 )] = $10.479(0.9713) - $9e (-0.06)(2) (0.9601) = $10.178 - $7.664
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Unformatted text preview: = $2.514 million. 13-8 P = PV as of time zero of all expected future cash flows if the project is repeated starting in year 2. Note it includes both the good cash flows and the bad cash flows since as of now, we don’t know which outcome will result, and P excludes the $20,000 investment in the franchise. 0 1 2 3 4 40% Prob . | | | | | Good 25,000 25,000 Bad | | | | | 60% Prob. 5,000 5,000 EPV of cash flows (as of time 0) = 35,858(0.40) + 7,172(0.60) = $18,646 = P. The strike price, X, is the cost to extend the franchise at the end of year 2, and is $20,000. The time to expiration is the time you decide whether or not to extend the franchise, and r = 10%...
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