LAL Corporation currently generates revenues of $1 million per year. Next year, revenues will either increase by 8.8% (economic boom) or decrease by 9.6% (economic bust), with equal probability, and then this level is expected to remain constant. Other costs run $880,000 per year. There are no costs to shutting down; in that case you can sell the company for $510,000. The cost of capital is 9.6%. What is the business worth today?

LAL Corporation currently generates revenues of $1 million per year. Next year, revenues will either increase by 8.8% (economic boom) or decrease by 9.6% (economic bust), with equal probability, and then this level is expected to remain constant. Other costs run $880,000 per year. There are no costs to shutting down; in that case you can sell the company for $510,000. The cost of capital is 9.6%. What is the business worth today?

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 8P

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LAL Corporation currently generates revenues of $1 million per year. Next year, revenues will either increase by 8.8% (economic boom) or decrease by 9.6% (economic bust), with equal probability, and then this level is expected to remain constant. Other costs run $880,000 per year. There are no costs to shutting down; in that case you can sell the company for $510,000. The cost of capital is 9.6%. What is the business worth today? Your answer should be in millions and accurate to two decimal places (e.g., $10,503,000 should be entered as 10.50).
Your company generates revenues of $5 million per year. Next year, company may get a long-term large contract, which will either increase by 15% or decrease by 20% (if contract is not signed) with equal probability. The new revenue will stay at that level forever. Operating costs are at $2 million dollars per year. You can sell the company at any time to $7 million and your cost of capital is 10%. What will be the value of your company if it gets the contract and the sales increase by 15%?
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You own a small manufacturing plant that currently generates revenues of $2 million per year. Next year, based upon a decision on a long-term government contract, your revenues will either increase by 20% or decrease by 25%, with equal probability, and stay at that level as long as you operate the plant. Other costs run $1.6 million per year. You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%. Assume that it will cost $1 million to shut down the plant, but you are able to sell the plant for $5 million at any time. What is the value of the option to sell the plant?
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