# Question

Consider a project that in one year pays $50 if the economy performs well (the stock market goes up) and that pays $100 if the economy performs badly (the stock market goes down). The probability of the economy performing well is 60%, the effective annual risk-free rate is 6%, the expected return on the market is 10%, and the beta of the project is −0.50.

a. Compute the present value of the project's cash flows using the true probabilities and expected return on the project.

b. Compute the risk-neutral probability of the economy performing well, then repeat the valuation of the project using risk-neutral valuation.

a. Compute the present value of the project's cash flows using the true probabilities and expected return on the project.

b. Compute the risk-neutral probability of the economy performing well, then repeat the valuation of the project using risk-neutral valuation.

## Answer to relevant Questions

Verify the binomial calculations in Figure 17.3. Consider the last row of Table 17.1. What is the solution for S*and S* when Ks = kr = 0? (This answer does not require calculation.) Consider again the project in Problem 17.2, only suppose that the widget price is unchanging and the cost of investment is declining at 2% per year. When will you invest? What is the value today of the project? What is Pr(St < $98) for t = 1? How does this probability change when you change t? Suppose you observe the following month-end stock prices for stocks A and B: For each stock: a. Compute the mean monthly continuously compounded return. What is the annual return? b. Compute the mean monthly standard ...Post your question

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