Suppose that research and development is

$

$4$

million initially and

$

$3$

million more for each of

the next

four

years. And suppose that at the end of the

firth year

the firm has an option to either

go ahead with the product or simply abandon it$.$ If the firm goes ahead with the development of

the product, this will require an investment of

$

$1$

$5$

$0$ million at the end of the

fifth year

$.$

A

ssume

that we can sell the investment in the product to another

party, that

is$,$

cash

out,

at

the end of the

f

ifth

year for

$

$1$

$45$

million. And, because we know that all of this is uncertain,

let us

attach

probabilities of this being a marketable product and, hence, one that the firm is able to cash out.

A

ssume that there is a

$55$

$\%$ chance that the firm can cash out for

$

$1$

$45$

million and a $4$

$5$

$\%$

chance that the firm cannot cash out at all

$.$

Required

Use the real options approach to determine the value of this project.

$(20$ marks$)$

BIU.AC$.$FC$.$FA$\mathrm{.}04$

ISSUE $1$

Effective Date: $01$

$-$

$04$

$-$

$2022$

Page

$1$

of

$2$

QUESTION

$2$

$[2$

$0$

MARKS$]$

You are

planning to

purchas

e

an empty block upon which you are considering developing a

residential villa complex.

The assumptions are:

$$

The land will cost $

$5$

$.$

$2$

million to purchase.

$$

Council contribution fees will be

$

$800$

$0$

$00.$

$$

The properties that we develop will be

$6$

$,000$ square metres in total.

$$

Building costs will be $$1,$

$6$

$00$ per square metre.

$$

We will sell the properties for $$3,$

$5$

$00$ per square metre.

$$

Sales commission to the estate agent will be

$1$

$\mathrm{.}5$ percent of the sale price.

REQURED

$($a$)$

Cr

eate

a

working model

for this business situation.

$(6$ marks$)$

$($b$)$

Using a Data Validation Drop

$-$

Down

in Excel, or otherwise, create built

$-$

in

Scenarios analysis model for the situation.

Use

t

he two input variables

$$

building cos

t

$$

and

$$

the sale price per square metre

$$ to develop the scenario analysis model

$.$

$(9$ marks$)$

$($c$)$

Prepare a executive summary of your scenario analysis results.

$(5$ marks$)$

END OF QUESTIONS

BIU.AC$.$FC$.$FA$\mathrm{.}04$