You are considering entering the shoe business. You believe that you have a narrow window for entering this market. Because of Christmas demand, the time is right today, and you believe that exactly a year from now would also be a good opportunity. Other than these two windows, you do not think another opportunity will exist to break into this business. It will cost you $35 million to enter the market. Because other shoe manufacturers exist and are public companies, you can construct a perfectly comparable company. Hence, you want to use the Black-Scholes formula to decide when and if you should enter the shoe business. Your analysis implies that the current value of your shoe company would be $40 million, and that the volatility is 25% per year. Of the $40 million current value, $6 million is coming from the free cash flows expected in the first year. The risk-free rate is 4%. What is the value of the investment opportunity if you choose to wait? (Hint: think of the investment as a call option) $1.03 million $5.72 million $3.54 million $10.29 million In the prior question, what is the value of the investment opportunity if you enter the shoe market today? And given this, when should you enter the market (if at all)? Value today $3 million... so enter next year $5 million ... so enter now Value today Value today -$1 million... so never enter Value today $34 million... so enter now
You are considering entering the shoe business. You believe that you have a narrow window for entering this market. Because of Christmas demand, the time is right today, and you believe that exactly a year from now would also be a good opportunity. Other than these two windows, you do not think another opportunity will exist to break into this business. It will cost you $35 million to enter the market. Because other shoe manufacturers exist and are public companies, you can construct a perfectly comparable company. Hence, you want to use the Black-Scholes formula to decide when and if you should enter the shoe business. Your analysis implies that the current value of your shoe company would be $40 million, and that the volatility is 25% per year. Of the $40 million current value, $6 million is coming from the free cash flows expected in the first year. The risk-free rate is 4%. What is the value of the investment opportunity if you choose to wait? (Hint: think of the investment as a call option) $1.03 million $5.72 million $3.54 million $10.29 million In the prior question, what is the value of the investment opportunity if you enter the shoe market today? And given this, when should you enter the market (if at all)? Value today $3 million... so enter next year $5 million ... so enter now Value today Value today -$1 million... so never enter Value today $34 million... so enter now
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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Just the second question. First is info to answer the second.
Transcribed Image Text:You are considering entering the shoe business. You believe that you have
a narrow window for entering this market. Because of Christmas demand,
the time is right today, and you believe that exactly a year from now would
also be a good opportunity. Other than these two windows, you do not
think another opportunity will exist to break into this business. It will cost
you $35 million to enter the market. Because other shoe manufacturers
exist and are public companies, you can construct a perfectly comparable
company. Hence, you want to use the Black-Scholes formula to decide
when and if you should enter the shoe business. Your analysis implies that
the current value of your shoe company would be $40 million, and that the
volatility is 25% per year. Of the $40 million current value, $6 million is
coming from the free cash flows expected in the first year. The risk-free
rate is 4%. What is the value of the investment opportunity if you choose
to wait? (Hint: think of the investment as a call option)
$1.03 million
$5.72 million
$3.54 million
$10.29 million
Transcribed Image Text:In the prior question, what is the value of the investment opportunity if
you enter the shoe market today? And given this, when should you enter
the market (if at all)?
Value today $3 million... so enter next year
$5 million ... so enter now
Value today
Value today
-$1 million... so never enter
Value today $34 million... so enter now
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