You are presented with an investment opportunity that costs $100M today. There is a 60 percent...

 

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You are presented with an investment opportunity that costs $100M today. There is a 60 percent chance that this investment will produce a perpetual annual free cash flow of $20M (good state) starting in the following year, and a 40 percent chance that it will produce a perpetual annual free cash flow of $10M (bad state) starting in the following year. Assume a discount rate of 12.5 percent. a) What is the NPV of this investment opportunity? (6 points) Suppose that you have the real option to delay your investment opportunity until t=4 so that you learn whether the investment opportunity will produce a perpetual cash flow of $20M or $10M starting next year. The drawback is that if you wait until t=4, the cost of the investment opportunity increases to $120M. b) Calculate the NPV of the investment opportunity at t=4 if you learn that the perpetual cash flow is $20M. Will you invest? (4 points) c) Calculate the NPV of the investment opportunity at t=4 if you learn that the perpetual cash flow is $10M. Will you invest? (4 points) d) What is the NPV at t=0 of this investment opportunity if you choose to wait until t=4 to invest? (Reminder: the probability of the good state is 60 percent and the probability of the bad state is 40 percent.) (6 points) You are presented with an investment opportunity that costs $100M today. There is a 60 percent chance that this investment will produce a perpetual annual free cash flow of $20M (good state) starting in the following year, and a 40 percent chance that it will produce a perpetual annual free cash flow of $10M (bad state) starting in the following year. Assume a discount rate of 12.5 percent. a) What is the NPV of this investment opportunity? (6 points) Suppose that you have the real option to delay your investment opportunity until t=4 so that you learn whether the investment opportunity will produce a perpetual cash flow of $20M or $10M starting next year. The drawback is that if you wait until t=4, the cost of the investment opportunity increases to $120M. b) Calculate the NPV of the investment opportunity at t=4 if you learn that the perpetual cash flow is $20M. Will you invest? (4 points) c) Calculate the NPV of the investment opportunity at t=4 if you learn that the perpetual cash flow is $10M. Will you invest? (4 points) d) What is the NPV at t=0 of this investment opportunity if you choose to wait until t=4 to invest? (Reminder: the probability of the good state is 60 percent and the probability of the bad state is 40 percent.) (6 points)

Answer rating: 100% (QA)

SOLUTION a The NPV of the investment opportunity can be calculated as the present value of the expec... View the full answer