You are in discussions to purchase an option on an office building with a strike price of$55 million. The building is currently valued at $50 million. The option will allow you topurchase the building either six months from today or one year from today. Six monthsfrom today, accrued rent payments from the building in the amount of $960,000 will bemade to the owners. If you exercise the option in six months, you will receive theaccrued rent payment; otherwise, the payment will be made to the current owners. Asecond accrued rent payment of $960,000 will be paid one year from today with thesame payment terms. The standard deviation of the value of the building is 40percent and the risk-free rate is an annual percentage rate of 6.2 percent. What is theprice of the option today using a two-state model with six-month steps? (Hint: The valueof the building in six months will be reduced by the accrued rent payment if you do notexercise the option at that time.) (Do not round intermediate calculations and enteryour answer in dollars, not millions of dollars, rounded to the nearest whole number,e.g., 1,234,567.)Answer is complete but not entirely correct.Price of the option today$1,303,546 x

Please comment down for any doubt. I hope my answer helps you.

Answered: You are in discussions to purchase an…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter19: Lease And Intermediate-term Financing

Section: Chapter Questions

Problem 1P

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es You are in discussions to purchase an option on an office building with a strike price of $56 million. The building is currently valued at $52 million. The option will allow you to purchase the building either six months from today or one year from today. Six months from today, accrued rent payments from the building in the amount of $970,000 will be made to the owners. If you exercise the option in six months, you will receive the accrued rent payment; otherwise, the payment will be made to the current owners. A second accrued rent payment of $970,000 will be paid one year from today with the same payment terms. The standard deviation of the value of the building is 45 percent and the risk-free rate is an annual percentage rate of 4.8 percent. What is the price of the option today using a two-state model with six-month steps? (Hint: The value of the building in six months will be reduced by the accrued rent payment if you do not exercise the option at that time.) (Do not round…
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