CORPORATE FINANCE (LL)-W/ACCESS
11th Edition
ISBN: 9781259976360
Author: Ross
Publisher: MCG
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 23, Problem 4QP
Real Options The Webber Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $55 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $53.2 million today. If demand increases, the building would be worth $57.9 million a year from today. If demand decreases, the same office building would be worth only $49.8 million in a year. The company can borrow and lend at the risk-free annual effective rate of 4.8 percent. A local competitor in the real estate business has recently offered $1.8 million for the right to build an office building on the land. Should the company accept this offer? Use a two-state model to value the real option.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
J&R Construction Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in down- town Sacramento over the next year. This building would cost $65 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $58.7 million today. If demand increases, the building would be worth $70.4 million a year from today. If demand decreases, the same office building would be worth only $55.2 million in a year. The company can borrow and lend at the risk-free annual effective rate of 4.8 percent. A local competitor in the real estate business has recently offered $1.8 million for the right to build an office building on the land. Should the company accept this offer? Use a two-state model to value the real option.
Companies invest in expansion projects with the expectation of increasing the earnings of their businesses. Consider the case of IQMetrics Corporation. IQMetrics is proceeding with a new expansion project that is anticipated to have a four-year life span. The project calls for the purchase of a building for $5 million and equipment valued at $3 million. IQMetrics’s corporate tax rate is 30%, and its discount rate is 10%. Upon completion of the project, the company expects the salvage values to be $4 million and $2 million, respectively. The capital cost allowance (CCA) rate for the asset classes as given by the Canada Revenue Agency (CRA) are buildings, 4%; equipment, 20%; and manufacturing assets, 30%. Calculate the present value for the total tax shield. The present value is
M1..
Industrialization Enterprise is considering a three-year project that will require an initial investment of $44,000. If market demand is strong, Industrialization Enterprise thinks that the project will generate cash flows of $28,500 per year. However, if market demand is weak, the company believes that the project will generate cash flows of only $1,500 per year. The company thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak.
If the company uses a project cost of capital of 14%, what will be the expected net present value (NPV) of this project? (Note: Do not round intermediate calculations and round your answer to the nearest whole dollar.)
-$9,176
-$8,258
-$7,800
-$11,011
Industrialization Enterprise has the option to delay starting this project for one year so that analysts can gather more information about whether demand will be strong or weak. If the company chooses to delay the project, it will have to give up a year of…
Chapter 23 Solutions
CORPORATE FINANCE (LL)-W/ACCESS
Ch. 23 - Employee Stock Options Why do companies issue...Ch. 23 - Real Options What are the two options that many...Ch. 23 - Project Analysis Why does a strict NPV calculation...Ch. 23 - Real Options Utility companies often face a...Ch. 23 - Prob. 5CQCh. 23 - Real Options Star Mining buys a gold mine, but the...Ch. 23 - Real Options You are discussing real options with...Ch. 23 - Real Options and Capital Budgeting Your company...Ch. 23 - Insurance as an Option Insurance, whether...Ch. 23 - Real Options How would the analysis of real...
Ch. 23 - Prob. 1QPCh. 23 - Prob. 2QPCh. 23 - Binomial Model Gasworks, Inc., has been approached...Ch. 23 - Real Options The Webber Company is an...Ch. 23 - Real Options Jet Black is an international...Ch. 23 - Real Options Sardano and Sons is a large, publicly...Ch. 23 - Real Options Wet for the Summer, Inc.,...Ch. 23 - Prob. 8QPCh. 23 - Binomial Model In the previous problem, assume...Ch. 23 - Real Options You are in discussions to purchase an...Ch. 23 - Prob. 1MCCh. 23 - Prob. 2MCCh. 23 - Your options, like most employee stock options,...Ch. 23 - Why do you suppose employee stock options usually...Ch. 23 - Prob. 5MCCh. 23 - Prob. 6MC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- The J.R. Ryland Computer Company is considering a plant expansion to enable the company to begin production of a new computer product. The companys president must determine whether to make the expansion a medium- or large-scale project. Demand for the new product is uncertain, which for planning purposes may be low demand, medium demand, or high demand. The probability estimates for demand are 0.20, 0.50, and 0.30, respectively. Letting x and y indicate the annual profit in thousands of dollars, the firms planners developed the following profit forecasts for the medium-and large-scale expansion projects. a. Compute the expected value for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of maximizing the expected profit? b. Compute the variance for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of minimizing the risk or uncertainty?arrow_forwardTalbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company’s tax rate is 25%. What is the initial investment outlay? The company spent and expensed $150,000 on research related to the new product last year. What is the initial investment outlay? Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. What is the initial investment outlay?arrow_forwardTalbot Industries is considering launching a new product. The new manufacturing equipment will cost 17 million, and production and sales will require an initial 5 million investment in net operating working capital. The companys tax rate is 40%. a. What is the initial investment outlay? b. The company spent and expensed 150,000 on research related to the new product last year. Would this change your answer? Explain. c. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for 1.5 million after taxes and real estate commissions. How would this affect your answer?arrow_forward
- REAL OPTIONS Boisjoly Enterprises is considering buying a vacant lot that sells for $ 1.4 million. If the property is purchased, the company's plan is to spend another $ 6 million today (t 0) to build a hotel on the property. The cash flows from the hotel will depend critically on whether the state imposes a tourism tax in this year's legislative session. If the tax is imposed, the hotel is expected to produce cash flows of $ 500,000 at the end of each of the next 15 years. If the tax is not imposed, the hotel is expected to produce cash flows of% 241,200,000 at the end of each of the next 15 years. The project has a 12% WACC. Assume at the outset that the company does not have the option to delay the project. a. What is the project's expected NPV if the tax is imposed? b. What is the project's expected NPV if the tax is not imposed? c. Given that there is a 45% chance that the tax will be imposed, what is the project's expected NPV if management proceeds with it today? d. Although the…arrow_forwardY7 J&R Construction Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $32 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $31 million today. If demand increases, the building would be worth $33.2 million a year from today. If demand decreases, the same office building would be worth only $29.5 million in a year. The company can borrow and lend at the risk-free annual effective rate of 6.5 percent. A local competitor in the real estate business has recently offered $768,000 for the right to build an office building on the land. What is the value of the office building today? Use the two-state model to value the real option. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g.,…arrow_forwardOptimal corporation wants to expand their manufacturing facilities. They have two choices, first to expand the current site at a cost of $290,000 per year for two years to complete the expansion, or to sell their current site for $1.3 million and purchase a new larger facility at a cost of $900,000 in the industrial zone. If the annual interest rate is 8%, evaluate the cash flows for the two options described above and decide which is the most financially beneficial to the corporation? [Note: you are supposed to show every step of your calculation and interpret the result. If Optimal corporation wants to factor inflation in their calculations, what is the equivalent nominal interest rate if expected inflation rate is 4% in the coming years? Critically discuss the significance of including the factor of inflation in corporate finance calculations.arrow_forward
- Optimal corporation wants to expand their manufacturing facilities. They have two choices, first to expand the current site at a cost of $290,000 per year for two years to complete the expansion, or to sell their current site for $1.3 million and purchase a new larger facility at a cost of $900,000 in the industrial zone. If the annual interest rate is 8%, evaluate the cash flows for the two options described above and decide which is the most financially beneficial to the corporation? [Note: you are supposed to show every step of your calculation and interpret the result.] If Optimal corporation wants to factor inflation in their calculations, what is the equivalent nominal interest rate if expected inflation rate is 4% in the coming years? Critically discuss the significance of including the factor of inflation in corporate finance calculations [Note: remember to use Harvard referencing to reference your sources]arrow_forwardJ&R constructions company owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $37.8 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $36 million today. If demand increases, the building would be worth $39.4 million a year from today. If demand decreases, the same office building would be worth only $35 million in a year. The company can borrow and lend at the risk-free annual effective rate of 7 percent. A local competitor in the real estate business has offered J&R Construction Company $X for the right to build an office building on the land. Use the binomial model to find the value of X that would leave J&R Construction Company indifferent to accepting or rejecting the offer. Assume risk-neutralityarrow_forwardSports Indirect Berhad plans to build a new plant to manufacture a new line of sports equipment. The project requires an initial outlay of RM4 million to construct the new plant in Year 0. The company needs an additional cash outlay of RM1 million to buy machinery at the end of the first year. The plot of land on which the new plant is to be built could otherwise be rented out for RM500,000 per annum before taxes. The company has to forego this rental income if they proceed with the construction of the new plant.The production of the new line of sports equipment is expected for only three years beginning in the second year. The company will close the operations of the plant and sell it at the end of the fourth year. The forecasted sales are as follows: Sales; Year 2=500,000 units Year 3=400,000 units Year 4=100,000 units Each unit of the new sports equipment can be sold for RM30 in the second year and the price is expected to increase by 6% per year in each of the subsequent years.…arrow_forward
arrow_back_ios
arrow_forward_ios
Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Cornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage Learning
Essentials of Business Analytics (MindTap Course ...StatisticsISBN:9781305627734Author:Jeffrey D. Camm, James J. Cochran, Michael J. Fry, Jeffrey W. Ohlmann, David R. AndersonPublisher:Cengage Learning
Excel Applications for Accounting PrinciplesAccountingISBN:9781111581565Author:Gaylord N. SmithPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Cornerstones of Financial Accounting
Accounting
ISBN:9781337690881
Author:Jay Rich, Jeff Jones
Publisher:Cengage Learning
Essentials of Business Analytics (MindTap Course ...
Statistics
ISBN:9781305627734
Author:Jeffrey D. Camm, James J. Cochran, Michael J. Fry, Jeffrey W. Ohlmann, David R. Anderson
Publisher:Cengage Learning
Excel Applications for Accounting Principles
Accounting
ISBN:9781111581565
Author:Gaylord N. Smith
Publisher:Cengage Learning
FIN 300 Lab 1 (Ryerson)- The most Important decision a Financial Manager makes (Managerial Finance); Author: AllThingsMathematics;https://www.youtube.com/watch?v=MGPGMWofQp8;License: Standard YouTube License, CC-BY
Working Capital Management Policy; Author: DevTech Finance;https://www.youtube.com/watch?v=yj-XbIabmFE;License: Standard Youtube Licence