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 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 $960,000 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 $960,000 will be paid one year from today with the same payment terms. The standard deviation of the value of the building is 40 percent and the risk-free rate is an annual percentage rate of 6.2 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 intermediate calculations and enter your 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

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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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 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 $960,000 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 $960,000 will be paid one year from today with the
same payment terms. The standard deviation of the value of the building is 40
percent and the risk-free rate is an annual percentage rate of 6.2 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 intermediate calculations and enter
your 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
Transcribed Image Text: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 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 $960,000 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 $960,000 will be paid one year from today with the same payment terms. The standard deviation of the value of the building is 40 percent and the risk-free rate is an annual percentage rate of 6.2 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 intermediate calculations and enter your 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
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