A company is building a distribution centre, with investment cost (year zero) of €200 million and present value (year zero) of cash flows of €180 million. However, the company has the option to sell this distribution centre at the end of next year. The company estimates that the market value of the distribution centre, within 1 year, will be €240 million if the market evolves favourably, and €120 million if the market evolves unfavourably. The risk- free interest rate is 2% per year and the project gross value is assumed to follow a multiplicative binomial process. The market value of the shadow asset is given by S. Currently S = 12 and the estimation is that, within 1 year, S = 19 and S = 7 for the scenarios of favourable and unfavourable market evolution, respectively. b. What is the expanded NPV of the project? Explain your answer.

A company is building a distribution centre, with investment cost (year zero) of €200 million and present value (year zero) of cash flows of €180 million. However, the company has the option to sell this distribution centre at the end of next year. The company estimates that the market value of the distribution centre, within 1 year, will be €240 million if the market evolves favourably, and €120 million if the market evolves unfavourably. The risk- free interest rate is 2% per year and the project gross value is assumed to follow a multiplicative binomial process. The market value of the shadow asset is given by S. Currently S = 12 and the estimation is that, within 1 year, S = 19 and S = 7 for the scenarios of favourable and unfavourable market evolution, respectively. b. What is the expanded NPV of the project? Explain your answer.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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OpenSeas, Inc. is evaluating the purchase of a new cruise ship. The ship will cost $499 million and will operate for 20 years. OpenSeas expects annual cash flows from operating the ship to be $69.6 million and its cost of capital is 12.0%. a. Prepare an NPV profile of the purchase. b. Identify the IRR on the graph. c. Should OpenSeas go ahead with the purchase? d. How far off could OpenSeas's cost of capital estimate be before your purchase decision would change? ...
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