Explanation The table that shows discounted future cash flows back to year 3 is as follows: 0 1 2 3 4 5 6 High $45 $45 $45 Average $30 $30 $30 Low $15 $15 $15 Table (1) Formula to calculate NPV in case of high demand is as follows: NPV = $ 45 ( 1 + 10 % ) + $ 45 ( 1 + 10 % ) 2 + $ 45 ( 1 + 10 % ) 3 = $ 111.91 Formula to calculate NPV in case of Average demand is as follows: NPV = $ 30 ( 1 + 10 % ) + $ 30 ( 1 + 10 % ) 2 + $ 30 ( 1 + 10 % ) 3 = $ 74.61 Formula to calculate NPV in case of low demand is as follows: NPV = $ 15 ( 1 + 10 % ) + $ 15 ( 1 + 10 % ) 2 + $ 15 ( 1 + 10 % ) 3 = $ 37.30 Formula to calculate current expected present value is as follows: Expected PV = 0.3 ( $ 111.91 1.1 3 ) + 0.4 ( $ 74.61 1.1 3 ) + 0.3 ( $ 37.30 1

Estimate: The value of the project with the growth option using financial option model.

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You were planning to purchase a house this month with a mortgage and just learned that the Fed is conducting open market purchase. Your situation is flexible in terms of the timing of the purchase; right now or later. It is assumed that everything else stays constant. What'd be the best strategy for your purchase? Explain using economic theory, not as a personal finance advisor

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Estimate: The value of the project with the growth option using financial option model.

Solution Summary: The author estimates the value of the project with the growth option using financial option model. The table shows discounted future cash flows back to year 3.

Estimate: The value of the project with the growth option using financial option model.

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Chapter 26 Solutions