You are planning to produce a new action figure called "Nia." However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $66 million per year for three years (starting next year [i.e., at t = 1]). If it fails, you will only have net cash flows of $26 million per year for two years (also starting next year). There is an equal chance that it will be a hit or failure (probability = 50 percent). You will not know whether it is a hit or a failure until the first year's cash flows are in (i.e., at t = 1). You must spend $112 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $76 million once the first year's cash flows are received, calculate the value of the abandonment option. (The discount rate is 10 percent.) Multiple Choice $23.80 −$7.37 $0.00 $16.43
You are planning to produce a new action figure called "Nia." However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $66 million per year for three years (starting next year [i.e., at t = 1]). If it fails, you will only have net cash flows of $26 million per year for two years (also starting next year). There is an equal chance that it will be a hit or failure (probability = 50 percent). You will not know whether it is a hit or a failure until the first year's cash flows are in (i.e., at t = 1). You must spend $112 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $76 million once the first year's cash flows are received, calculate the value of the abandonment option. (The discount rate is 10 percent.)
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$23.80
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−$7.37
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$0.00
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$16.43
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