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This question was created from Option Pricing Application.pdf


4. You are analyzing a capital budgeting project. The project is expected to have a PV of cash inflows of $250
million and will cost $200 million (in present value dollars) to take on. You have done a simulation of the
project cashflows and the simulation yields a variance in present value of cash inflows of 0.04. You have the
rights to this project for the next five years, during which period you have to pay $12.5 million a year to
retain the project rights. The five-year treasury bond rate is 8%.
a. What is the value of project, based upon traditional NPV?
What is the value of the project as an option?
c. Why are the two values different? What factor or factors determine the magnitude of this difference?

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