An antique collector is deciding between opening a business now or 1.5 years later. To open...

 

Transcribed Image Text:

An antique collector is deciding between opening a business now or 1.5 years later. To open now, she estimates that the initial costs amount to $230,000 and the present value of the sales is $350,000. If instead she opens her business 1.5 years later, she expects that the costs to be paid at that time grow at a compound interest rate of 6.5% per annum. To describe the uncertainty in the evolution of the sales figure, she uses a binomial tree model with an up step of u = 1.3 and a down step of d = 0.7 every six months. The risk-free effective interest rate is 3% per annum. (a) Determine whether she should open her business now or 1.5 years later, and calculate the current value of the (real) option to delay. [7 marks] (b) If the beta of the antique business itself is 2.5, what is the beta of the whole project? An antique collector is deciding between opening a business now or 1.5 years later. To open now, she estimates that the initial costs amount to $230,000 and the present value of the sales is $350,000. If instead she opens her business 1.5 years later, she expects that the costs to be paid at that time grow at a compound interest rate of 6.5% per annum. To describe the uncertainty in the evolution of the sales figure, she uses a binomial tree model with an up step of u = 1.3 and a down step of d = 0.7 every six months. The risk-free effective interest rate is 3% per annum. (a) Determine whether she should open her business now or 1.5 years later, and calculate the current value of the (real) option to delay. [7 marks] (b) If the beta of the antique business itself is 2.5, what is the beta of the whole project?

Answer rating: 100% (QA)

a She should open her business now b The beta of the whole project ... View the full answer