I was already given the correct answer for Parts A-C. The equation I was given was = -(1.4+6)+ .5/.12*(1-1/1.12^15). I was wondering what the numbers correlate to in the problem though, specifically, where do these numbers come from in the text? .5/.12*(1-1/1.12^15)
I was already given the correct answer for Parts A-C. The equation I was given was = -(1.4+6)+ .5/.12*(1-1/1.12^15). I was wondering what the numbers correlate to in the problem though, specifically, where do these numbers come from in the text? .5/.12*(1-1/1.12^15)
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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I was already given the correct answer for Parts A-C. The equation I was given was = -(1.4+6)+ .5/.12*(1-1/1.12^15). I was wondering what the numbers correlate to in the problem though, specifically, where do these numbers come from in the text?
.5/.12*(1-1/1.12^15)
Transcribed Image Text:Real Options Boisjoly Enterprises is considering buying a vacant lot that sells for $1.4 million. If the property is
purchased, the company's plan is to spend another $6 million today to build a hotel on the property. The cash
flows from the hotel will depend critically on whether the state imposes a tourism tax in this year's legislative
session. If the tax is imposed, the hotel is expected to produce cash flows of $500,000 at the end of each of the
next 15 years. If the tax is not imposed, the hotel is expected to produce cash flows of $1,200,000 at the end of
each of the next 15 years. The project has a 12% WACC. Assume at the outset that the company does not have the
option to delay the project.
a. What is the project's expected NPV if the tax is imposed?
b. What is the project's expected NPV if the tax is not imposed?
c. Given that there is a 45% chance that the tax will be imposed, what is the project's expected NPV if
management proceeds with it today?
d. Although the company does not have an option to delay construction, it does have the option to abandon the
project 1 year from now if the tax is imposed. If it abandons the project, it will sell the complete property 1 year
from now at an expected price of $7 million after taxes. Once the project is abandoned, the company will no
longer receive any cash flows. Assuming that all cash flows are discounted at 12%, will the existence of this
abandonment option affect the company's decision to proceed with the project today? Explain.
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