a) Dreamline Company is a leading firm in the heavy machines sector, manufacturing plants for both corporate entities and the government Following a successful government policy, Dreamline is in line to win a big contract to manufacture plants for waste recycling across the country. The company' s most recent revenue is ￡2 million per year； this revenue will potentially increase by 20%or decrease by 25% depending on the outcome of the bid for the contract. There is an equal probability of the revenue increase or decrease. It will also cost ￡1.6 million annually to run the plants However,  Dreamline has the option to sell the plants to another company for ￡5 million. The cost of capital is 10%

b) "A complete contract would completely specify every action of every party to the contract in every state of the world". However, most real-world contracts tend to be incomplete. Identify and explain four (4) consequences of incomplete contracts

i. Find the value of the plant given the embedded option to sell the plant

ii. Assume that  Dreamline  is not able to sell the plant, but it is able to shut down the plant at no cost at any time What is the value of the option to abandon production？

iii. Assume that it will cost the firm ￡1 million to shut down the plant, but it is able to sell the plant for ￡5 million at any time. Determine the value of the option to sell the plant

iv. Draw a decision tree assuming Dreamline is not able to sell the pla but it is able to shut down the plant at no cost at any time

Answer rating: 100% (QA)

a 1 Value of plant cost of capital revenue annual fees 10 of 5 million 2 million 16 mllion 41 millio... View the full answer