Zeta Airlines Co will open a new flight route to Sapporo, Japan. Zeta hopes that there will be high demand for the new flight route due to the relative decline in the value of the Japanese Yen. This flight route requires an initial investment of $5 million. If demand is high, Zeta will make $5 million per annum in perpetuity. If demand is low, Zeta will make $1 million per annum in perpetuity. The probability that demand is high is 40% and the probability that the demand is low is 60%. Zeta will find out whether demand is high or low after the investment has been made. Once demand is high or low, it does not change. To encourage tourism, the Japanese government will give Zeta the option to abandon operations after 3 years of flying. 

If Zeta exercises this option, it will sell all related assets to the Japanese government for $10 million. Zeta’s required rate of return is 15%. What is the value of this option? (Round the final answer to the nearest two digits.)

Answer rating: 100% (QA)

To determine the value of the optionwe need to calculate the expected value of the option considerin... View the full answer