11. Consider a production facility, where the present value of expected future cash inflows from production,...

 

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11. Consider a production facility, where the present value of expected future cash inflows from production, V = 100, may fluctuate in line with the random fluctuation in demand (u = 1.8, d = 0.56 per period and the risk-free rate, r = 5%). Suppose management has the option in two years, to contract to half the scale and half the value of the project (c = 50%), and recover $50m (Rc = $50m). Thus, in year 2 management has the flexibility either to maintain the same scale of operations (i.e., receive project value, V, at no extra cost) or contract the scale of operations and receive the recovery amount, whichever is highest. What are the pay-offs of this option at the end nodes (thus in the different states after 2 periods)? The payoffs, F, of the option in the end note states are respectively: F = 324, F= 100, F = 31 The payoffs, F, of the option in the end note states are respectively: F = 0, F = 0, F = 40 The payoffs, F, of the option in the end note states are respectively: F = 112, F= 0, F = 0 The payoffs, F, of the option in the end note states are respectively: F = 0,F = 0, F = 35 11. Consider a production facility, where the present value of expected future cash inflows from production, V = 100, may fluctuate in line with the random fluctuation in demand (u = 1.8, d = 0.56 per period and the risk-free rate, r = 5%). Suppose management has the option in two years, to contract to half the scale and half the value of the project (c = 50%), and recover $50m (Rc = $50m). Thus, in year 2 management has the flexibility either to maintain the same scale of operations (i.e., receive project value, V, at no extra cost) or contract the scale of operations and receive the recovery amount, whichever is highest. What are the pay-offs of this option at the end nodes (thus in the different states after 2 periods)? The payoffs, F, of the option in the end note states are respectively: F = 324, F= 100, F = 31 The payoffs, F, of the option in the end note states are respectively: F = 0, F = 0, F = 40 The payoffs, F, of the option in the end note states are respectively: F = 112, F= 0, F = 0 The payoffs, F, of the option in the end note states are respectively: F = 0,F = 0, F = 35

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ANSWER D The payoffs F of the option in the end note states are respectively F 0 F 0 F 35 The presen... View the full answer