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) $5.72 million $3.54 million $10.29 million $1.03 million
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) $5.72 million $3.54 million $10.29 million $1.03 million
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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Please show all equations and work as needed. If possible, please type the work so that it may be copied and pasted. Thank you.
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)
$5.72 million
$3.54 million
$10.29 million
$1.03 million
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