Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows. What is the expected value of the plant with the option to sell it? A. $3.75 million B. $3.90 million C. $4.25 million D. $4.50 million
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows. What is the expected value of the plant with the option to sell it? A. $3.75 million B. $3.90 million C. $4.25 million D. $4.50 million
Chapter11: Cash Flow Estimation And Risk Analysis
Section: Chapter Questions
Problem 8P
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Question
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of
$2 million per year. Based on uncertainty surrounding its long term government
contract, next year’s revenue will either increase by 20% or decrease by 25%, with
equal probability and then stay the same forever. Mosaic projected that the costs will
be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant
for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash
flows.
What is the expected value of the plant with the option to sell it?
A. $3.75 million
B. $3.90 million
C. $4.25 million
D. $4.50 million
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