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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?

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?

Essentials Of Investments
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
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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?
Transcribed Image Text: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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