(b) Fedelity PLC has a £1000 million investment opportunity that generates £425 million in cash flows per year for three consecutive years. Cash flows are realised at the end of each year. The firm could decide to close down the project immediately after inception and would recover £900 million. The firm could also choose to abandon the project and sell off assets at the beginning of year 2 and recover £800 million or £450 with equal chance. The firm also could sell off assets at the beginning of year 3 and realise £375 million with 40% chance or £150 million with 60% chance. Assume the discount rate is 6%. Advise the firm whether and when it should exercise the option (i.e. abandon the project) and calculate the value of the option.

(b) Fedelity PLC has a £1000 million investment opportunity that generates £425 million in cash flows per year for three consecutive years. Cash flows are realised at the end of each year. The firm could decide to close down the project immediately after inception and would recover £900 million. The firm could also choose to abandon the project and sell off assets at the beginning of year 2 and recover £800 million or £450 with equal chance. The firm also could sell off assets at the beginning of year 3 and realise £375 million with 40% chance or £150 million with 60% chance. Assume the discount rate is 6%. Advise the firm whether and when it should exercise the option (i.e. abandon the project) and calculate the value of the option.

Name: (b) Fedelity PLC has a £1000 million investment opportunity that gene
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Description: (b) Fedelity PLC has a £1000 million investment opportunity that generates £425million in cash flows per year for three consecutive years. Cash flows are realisedat the end of each year. The firm could decide to close down the projectimmediately aft

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter26: Real Options

Section: Chapter Questions

Problem 3P: Wansley Lumber is considering the purchase of a paper company, which would require an initial...

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