You are considering the expansion options for your airline based in Brisbane. Honolulu International airport offers...

 

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You are considering the expansion options for your airline based in Brisbane. Honolulu International airport offers you a contract for three direct flights a week in perpetuity. The agreement gives you the ability to break the contract after three years if you wish. While the contract remains current you will pay $100000 per month to the airport for parking and fuelling costs. You are uncertain whether this route will be a success or not, but you predict that there is a 60% chance that it will be. In the case that it is successful you will receive monthly revenues of $250000 for the life of the contract. Otherwise you will receive cash flows of $150000 per month. You will know after one year whether the new route is a success or not. The risk-free interest rate is 8% per year. Also, because the route is longer than your current routes you will need to purchase a larger plane for the cost of $20000000. If and when you break the contract you will sell the plane for $18000000. A. What is the value of this investment opportunity given that you have the option to abandon the project in year 3? (10 Marks) B. If you did not have the option to abandon the project, what would be the NPV of the project? (5 Marks) C. What is the value of the option? (5 Marks) You are considering the expansion options for your airline based in Brisbane. Honolulu International airport offers you a contract for three direct flights a week in perpetuity. The agreement gives you the ability to break the contract after three years if you wish. While the contract remains current you will pay $100000 per month to the airport for parking and fuelling costs. You are uncertain whether this route will be a success or not, but you predict that there is a 60% chance that it will be. In the case that it is successful you will receive monthly revenues of $250000 for the life of the contract. Otherwise you will receive cash flows of $150000 per month. You will know after one year whether the new route is a success or not. The risk-free interest rate is 8% per year. Also, because the route is longer than your current routes you will need to purchase a larger plane for the cost of $20000000. If and when you break the contract you will sell the plane for $18000000. A. What is the value of this investment opportunity given that you have the option to abandon the project in year 3? (10 Marks) B. If you did not have the option to abandon the project, what would be the NPV of the project? (5 Marks) C. What is the value of the option? (5 Marks)

Answer rating: 100% (QA)

The net present value of the contract is 14737502 Assuming that the interest rate is 8 per year we c... View the full answer