fm13 20 - Answer: Suppose the cost of the project is $75...

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Mini Case: 13 - 20 Now, we proceed to use the OPM: V = $67.83[N(d 1 )] - $70e -(0.06)(1) [N(d 2 )]. d 1 = 5 . 0 ) 1 ( 5 . 0 ) 142 (. ) 15 )]( 0.142/2 06 . 0 [( ) $67.83/$70 ln( + + = 0.2641. d 2 = d 1 - (0.142) 0.5 (1) 0.5 = 0.2641 - 0.3768 = -0.1127. N(d 1 ) = N(0.2641) = 0.6041. N(d 2 ) = N(-0.1127) = 0.4551. therefore, V = $67.83(0.6041) - $70e -0.06 (0.4551) = $10.98. g. Now suppose the cost of the project is $75 million and the project cannot be delayed. But if Tropical Sweets implements the project, then Tropical Sweets will have a growth option. It will have the opportunity to replicate the original project at the end of its life. What is the total expected NPV of the two projects if both are implemented?
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Unformatted text preview: Answer: Suppose the cost of the project is $75 million instead of $70 million, and there is no option to wait. NPV = PV of future cash flows - cost = $74.61 - $75 = -$0.39 million. The project now looks like a loser. Using NPV analysis: NPV = NPV Of Original Project + NPV Of Replication Project = -$0.39 + -$0.39/(1+0.10) 3 = -$0.39 + -$0.30 = -$0.69. Still looks like a loser, but you will only implement project 2 if demand is high. We might have chosen to discount the cost of the replication project at the risk-free rate, and this would have made the NPV even lower....
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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