Acme Co has decided to make an investment into the electric bicycle business. Acme will need to invest $1,500,000, and production will start immediately. If there is high demand for Acme’s electric bicycles (with 20% probability), then it will continue to have high demand and generate $300,000 every year in perpetuity. If there is low demand for Acme’s electric bicycles (with 80% probability), then it will have low demand for two years and generate $50,000 each year for two years. After the two years of low demand, there is another possibility for high or low demand Acme’s electric bicycles. If there is high demand for Acme’s electric bicycles after two years of low demand (with 30% probability), then it will generate $300,000 each year in perpetuity. If there is low demand for Acme’s electric bicycles after two years of low demand (with 70% probability), then it will generate $50,000 each year in perpetuity. Acme’s annual required rate of return is 10%. Assume cash flows occur at the end of each year, except for initial cash flows. To encourage investment into electric bicycles, the government is offering Acme an option to abandon its operations and sell all related assets for $1 million at the end of year 4. If Acme chooses the option to sell all related assets to the government, it will not receive the cash flows generated from the electric bicycle business in that year. What is the value of this option? Round to the nearest dollar. Group of answer choices a. $216,681 b. $155,573 c. None of the other answers are correct. d. $191,943 e. $172,199
Acme Co has decided to make an investment into the electric bicycle business. Acme will need to invest $1,500,000, and production will start immediately. If there is high demand for Acme’s electric bicycles (with 20% probability), then it will continue to have high demand and generate $300,000 every year in perpetuity. If there is low demand for Acme’s electric bicycles (with 80% probability), then it will have low demand for two years and generate $50,000 each year for two years. After the two years of low demand, there is another possibility for high or low demand Acme’s electric bicycles. If there is high demand for Acme’s electric bicycles after two years of low demand (with 30% probability), then it will generate $300,000 each year in perpetuity. If there is low demand for Acme’s electric bicycles after two years of low demand (with 70% probability), then it will generate $50,000 each year in perpetuity. Acme’s annual required
To encourage investment into electric bicycles, the government is offering Acme an option to abandon its operations and sell all related assets for $1 million at the end of year 4. If Acme chooses the option to sell all related assets to the government, it will not receive the cash flows generated from the electric bicycle business in that year. What is the value of this option? Round to the nearest dollar.
Group of answer choices
a. $216,681
b. $155,573
c. None of the other answers are correct.
d. $191,943
e. $172,199
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