Real Options You are in discussions to purchase an option on an office building with a strike price of $63 million. The building is currently valued at S60 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 $900,000 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 $900,000 will be paid one year from today with the same payment terms. The standard deviation of the value of the building is 30 percent, and the risk-free rate is a 6 percent annual percentage rate. What is the price of the option today using 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.)
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Chapter 23 Solutions
UPENN: LOOSE LEAF CORP.FIN W/CONNECT
- Assume that you are about to sell property (a vacant parcel of real estate) you own but otherwise have no use for. The net-of-sales- commission selling price for the property is $450,000. You are willing to finance this transaction over a 14-year period and have told the buyer that you expect a 11% pretax return on the transaction. The buyer has asked you for a payment schedule under several alternatives. Required: 1. What will be your periodic cash receipt, to earn a 11% return, if payments are received from the purchaser: NOTE: to answer the above questions, use the PMT function in Excel, as follows: PMT(rate,nper, pv,fv,type) where: rate is the interest rate for the loan, nper is the total number of payments, pv is the present value (i.e., the total amount that a series of future payments is worth now; also known as the principal), fv is the future value (or a cash balance you want to attain after the last payment is made; if fv is omitted, it is assumed to be 0 (zero)), and type is…arrow_forwardAssume that you are about to sell property (a vacant parcel of real estate) you own but otherwise have no use for. The net-of-sales-commission selling price for the property is $500,000. You are willing to finance this transaction over a 20-year period and have told the buyer that you expect a 12% pretax return on the transaction. The buyer has asked you for a payment schedule under several alternatives. Required: 1. What will be your periodic cash receipt, to earn a 12% return, if payments are received from the purchaser: NOTE: to answer the above questions, use the PMT function in Excel, as follows: PMT(rate,nper,pv,fv,type) where: rate is the interest rate for the loan, nper is the total number of payments, pv is the present value (i.e., the total amount that a series of future payments is worth now; also known as the principal), fv is the future value (or a cash balance you want to attain after the last payment is made; if fv is omitted, it is assumed to be 0 (zero)), and…arrow_forwardUse a bankers year: 360 days To complete the sale of a house, the you accept a 240-day note for $9,000 at 7% simple interest. (Both interest and principal are repaid at the end of the 240 days.) Wishing to use the money sooner for the purchase of another house, the you sell the note to a third party for $9,108 after 80 days. What annual simple interest rate will the third party receive for the investment? Express your answer as a percentage.arrow_forward
- Peter Lynchpin wants to sell you an investment contract that pays equal $13,500 amounts at the end of each of the next 19 years. If you require an effective annual return of 10 percent on this investment, how much will you pay for the contract today?arrow_forwardA case study analysis of leasing business equipment compared to purchasing the same equipment.How do you determine whether you should lease or buy a piece of equipment for your business? Let's assume you're faced with the following lease-or-buy decision:You can purchase a $50,000 piece of equipment by putting 25 percent down and paying off the balance at 10 percent interest with four annual installments of $11,830. The equipment will be used in your business for eight years, after which it can be sold for scrap for $2,500.The alternative is that you can lease the same equipment for eight years at an annual rent of $8,500, the first payment of which is due on delivery. You'll be responsible for the equipment's maintenance costs during the lease.You expect that your combined federal and state income tax rate will be 40 percent for the entire period at issue. You further assume that your cost of capital is 6 percent (the 10 percent financing rate adjusted by your tax rate).Question:Using…arrow_forwardA buyer is considering purchasing a 10-acre parcel in Peoria, Arizona for economic development. The parcel has a sales price of $720,000. The buyer agrees with the seller for purchasing the property with 15% down up front and paying off the balance in 12-months. If a bank is willing to provide 3% annual interest, compounded monthly, how much should the monthly deposit be into that account to pay off the desired balance to the seller?arrow_forward
- A manufacturer can lease a machine for 6 years at $3,680 per quarter, payable at the beginning of each quarter. Alternatively, they can purchase the machine for $76,000 and sell it for $8,700 in 6 years. The cost of capital is 9.1% compounded annually. a. What is the present value of the cost: (enter a positive value accurate to the nearest dollar) i) of the lease option? ii) of the purchase option? GAarrow_forwardEXERCISE 2: LEASING VERSUS BUYING You have two options: to buy or to lease a video store. Option 1: Purchase Year $300,000 80,000 Cost Additional cost Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations Cash flow from operations 1 45,000 70,000 1 90,000 105,000 140,000 3 4. 6. 160,000 165,000 170,000 175,000 180,000 10 11 Cash flow from sale of business 400,000 If you want to make 25% on your money, should you buy the video store? To answer this question, calculate the following: 1. Net present value 2. Internal rate of return Option 2: Leasing Activate Go to Settinarrow_forwardA computer dealer offers(a) to lease a system to you for $50 permonth for two years. At the end of two years, you have the option to buy the system for $500. You will pay at the end of each month.(b) He will sell the same system to you for $1,200 cash.If the going interest rate is 12%, which is the better offer (a) or (b)?arrow_forward
- You are considering an option to purchase or rent a single residential property. You can rent it for $2,000 per month and the owner would be responsible for maintenance, property insurance, and property taxes. Alternatively, you can purchase this property for $200,000 and finance it with an 80 percent mortgage loan at 4 percent fixed-rate interest that will fully amortize over a 30-year period. The loan requires monthly payments. The loan can be prepaid at any time with no penalty. You have done research in the market area and found that (1) properties have historically appreciated at an annual rate of 2 percent per year, and rents on similar properties have also increased at 2 percent annually; (2) maintenance and insurance are currently $1,500.00 each per year and they have been increasing at a rate of 3 percent per year; (3) you are in a 24 percent marginal tax rate and plan to occupy the property as your principal residence for at least four years; (4) the capital gains exclusion…arrow_forwardA manufacturer can lease a machine for 7 years at $3,000 per quarter, payable at the beginning of each quarter. Alternatively, they can purchase the machine for $78,000 and sell it for $8,700 in 7 years. The cost of capital is 6.2% compounded annually. a. What is the present value of the cost: (enter a positive value accurate to the nearest dollar) i) of the lease option? $ ii) of the purchase option? $ b. Should the manufacturer purchase or lease? O Purchase since Purchase PV is higher than Lease PV O Lease since Lease PV is higher than Purchase PV O Lease since Purchase PV is lower than Lease PV O Purchase since Lease PV is lower than Purchase PV Lease since Lease PV is lower than Purchase PV Purchase since Lease PV is higher than Purchase PV Submit Questionarrow_forwardThe owner of a local restaurant needs to decide between two lease options as presented below for the next 3 years. Option 1: A fixed fee of 540,000 plus 4% of the total sales. Option 2: Afixed fee of 560,000 plus 2% of the total sales. The business is recently crated, and the owner's projected sales will reach 5700,000 in the third year: and it will grow by 10% per year for the next several years. Which one of the following would you recommend, and why? - More information is neede a to solve for the answer Either option does not make differrece because the amount of revenues 25 51,000,000 is the Indifference Pont. Phis it doesn't matter Select the Oation I for the neast 3 yearse and renew the lease contract in thie fourth yor wili De kution 2 Select the Ostion 2 for the first 3 years, and switch it to the Opeis a The theoretinaarrow_forward
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