As a final point, Coleman Ltd insist that they should have the right to walk away from the contract at the end of the first year if the price of copper is below the benchmark rate. In that case, you estimate that they would be able to sell their transport equipment for $1.5 million. The required rate of return for the project is 12% per annum. (a) If the price of copper was below the benchmark rate in the first year of the contract, would you advise Coleman Ltd to exercise their option to walk away from the project at the end of the first year? (show all workings) (b) What is the total value of the contract to Coleman Ltd today?
As a final point, Coleman Ltd insist that they should have the right to walk away from the contract at the end of the first year if the price of copper is below the benchmark rate. In that case, you estimate that they would be able to sell their transport equipment for $1.5 million. The required rate of return for the project is 12% per annum. (a) If the price of copper was below the benchmark rate in the first year of the contract, would you advise Coleman Ltd to exercise their option to walk away from the project at the end of the first year? (show all workings) (b) What is the total value of the contract to Coleman Ltd today?
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
Related questions
Question
Please try to solve it in 30 minute
Transcribed Image Text:Coleman Ltd is a transport company that has been asked to assess an opportunity to provide services to a
mining company, Aztec Ltd, that extracts copper in Western Australia. The 10-year contract provides that
the cash flows paid to Coleman Ltd at the end of each of the 10 years of the contract are a function of the
international price for copper during only the first year of the contract. Specifically, if the average price of
copper in the first year is greater than a benchmark price, then the contract allows for Coleman Ltd to be
paid a net cash flow of $1,000,000 per annum over the life of the contract. If the average price of copper
in the first year of the contract is less than the benchmark price, then Coleman Ltd enjoys a net cash flow
of only $250,000 per annum over the life of the contract.
You estimate that there is a 60% chance that the price of copper will exceed the benchmark rate in the
first year of the contract. You also estimate that Coleman Ltd will have to invest $2 million initially to
purchase the specialized transport equipment necessary to service the contract.
As a final point, Coleman Ltd insist that they should have the right to walk away from the contract at the
end of the first year if the price of copper is below the benchmark rate. In that case, you estimate that they
would be able to sell their transport equipment for $1.5 million.
The required rate of return for the project is 12% per annum.
(a) If the price of copper was below the benchmark rate in the first year of the contract, would you advise
Coleman Ltd to exercise their option to walk away from the project at the end of the first year? (show all
workings)
(b) What is the total value of the contract to Coleman Ltd today?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 2 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education