Growth Option: Option Analysis Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $25,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $5,000 per year for 2 years. Fethe's cost of capital is 10%. a. What is the expected NPV of the project? Round your answer to the nearest dollar. b. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Use the Black-Scholes model to estimate the value of the option. Assume the variance of the project's rate of return is 0.2351 and that the risk-free rate is 7%. Do not round intermediate calculations. Round your answers to the nearest dollar. Use computer software packages, such as Minitab or Excel, to solve this problem. Value of the growth option: $ Value of the entire project: $
Growth Option: Option Analysis Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs for University of Tennessee football games. The purchase cost for a 2-year franchise to sell the wigs is $20,000. If demand is good (40% probability), then the net cash flows will be $25,000 per year for 2 years. If demand is bad (60% probability), then the net cash flows will be $5,000 per year for 2 years. Fethe's cost of capital is 10%. a. What is the expected NPV of the project? Round your answer to the nearest dollar. b. If Fethe makes the investment today, then it will have the option to renew the franchise fee for 2 more years at the end of Year 2 for an additional payment of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be repeated (so if demand was good in Years 1 and 2, it will continue to be good in Years 3 and 4). Use the Black-Scholes model to estimate the value of the option. Assume the variance of the project's rate of return is 0.2351 and that the risk-free rate is 7%. Do not round intermediate calculations. Round your answers to the nearest dollar. Use computer software packages, such as Minitab or Excel, to solve this problem. Value of the growth option: $ Value of the entire project: $
Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter26: Real Options
Section: Chapter Questions
Problem 5P
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Transcribed Image Text:Growth Option: Option Analysis
Fethe's Funny Hats is considering selling trademarked, orange-haired curly wigs
for University of Tennessee football games. The purchase cost for a 2-year
franchise to sell the wigs is $20,000. If demand is good (40% probability), then
the net cash flows will be $25,000 per year for 2 years. If demand is bad (60%
probability), then the net cash flows will be $5,000 per year for 2 years. Fethe's
cost of capital is 10%.
a. What is the expected NPV of the project? Round your answer to the nearest
dollar.
b. If Fethe makes the investment today, then it will have the option to renew the
franchise fee for 2 more years at the end of Year 2 for an additional payment
of $20,000. In this case, the cash flows that occurred in Years 1 and 2 will be
repeated (so if demand was good in Years 1 and 2, it will continue to be good
in Years 3 and 4). Use the Black-Scholes model to estimate the value of the
option. Assume the variance of the project's rate of return is 0.2351 and that
the risk-free rate is 7%. Do not round intermediate calculations. Round your
answers to the nearest dollar.
Use computer software packages, such as Minitab or Excel, to solve this
problem.
Value of the growth option: $
Value of the entire project: $
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