Paste BIU K24 A Fx B D E > 9 10 8 A firm is considering a project in South Jersey with PV of expected cash flows of $75 M but requires an initial investment of $85 M. However, as a result of undertaking this project, the firm can establish operations in North Jersey operations by investing $100 M at the end of two years. The North Jersey operations is expected to have a present value of $90 M at a required return or (discrete) wacc of 12% and has a volatility of 20%. The (discrete) risk-free rate is 4%. 11 Use a four-step binomial tree to calculate the value of the option to establish the North Jersey operations. 12 13 What is the optimal option exercise policy? 24 15 16 27 18 19 Type 20 UNDO 21 22 23 r(discrete) 24 r(continuous) 25 a(sigma) 26 T 27 N 28 dt 29 30 u 31 d AT= u = d = e 32 33 q 34 35 X 36 37 38 UND 39 40 41 42 43 44 45 46 DERIV 01 Q2 Q3 Q4 Ready + 34 95 X 96 37 38 UND 39 40 41 42 43 44 45 45 DERIV 47 48 49 50 $1 52 53 54 OPTION EXERCISE POLICY 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 0 3 0 In words, summarize the optimal investment/divestment policy. B C D E G H 7 8 Excel is required for this homework. On the shaded cells, enter excel formuls referring to cell addresses of relevant data. Save your files as an Excel File. The American option problems are similar to handout H22 on Reggienet. The European option problems have a simpler stucture than American: Just as in HW3, option exercise is allowed only at terminal nodes. A firm is considering a project in South Jersey with PV of expected cash flows of $75 M but requires an initial investment of $85 M. However, as a result of undertaking this project, the firm can establish operations in North Jersey operations by investing $100 M at the end of two years. The North Jersey operations is expected to have a present value of $90 M at a required return or (discrete) wacc of 12% and has a volatility of 20%. The (discrete) risk-free rate is 4%. 9 10 11 12 Use a four-step binomial tree to calculate the value of the option to establish the North Jersey operations. 13 What is the optimal option exercise policy? 14 15 16 17 18 19 Type 20 UNDO 21 22 23 r (discrete) 24 r (continuous) 25 a (sigma) 26 T 27 N 28 dt 29 30 u 31 AT= u = d = eA 9 = -d u-d d 32 33 q 34 35 X 36 01 02 00 Q3