Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 26, Problem 8P
Summary Introduction
To calculate: The value of option using Black Scholes model.
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An expansion project that has an expected return of 25% and a standard deviation of 30%. Find the project's coefficient of variation?
a) 1.32
b) 0.83
c) 1.20
d) 1.39
e) 1.26
The return expected from the project no. 542 is 22 percent. The standard deviation of these return is 11 percent. If returns from the project are normally distributed. What is the chance that the project will result in a rate of return above 33 percent?
A project under consideration has an internal rate of return of 16% and a beta of 0.9. The risk-free rate is 6%, and the expected rate of return on the market portfolio is 16%.
a. What is the required rate of return on the project? (Do not round intermediate calculations. Enter your answer as a whole percent.)
b. Should the project be accepted?
c. What is the required rate of return on the project if its beta is 1.90? (Do not round intermediate calculations. Enter your answer as a whole percent.)
d. If the project's beta is 1.90, should the project be accepted?
Chapter 26 Solutions
Financial Management: Theory & Practice
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- Investment Timing Option: Option Analysis Rework Problem 14-1 using the Black-Scholes model to estimate the value of the option. Assume that the variance of the project’s rate of return is 0.0687 and that the risk-free rate is 8%. 14–1 Investment Timing Option: Decision-Tree Analysis Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $20 million. Kim expects the hotel will produce positive cash flows of $3 million a year at the end of each of the next 20 years. The project’s cost of capital is 13%. a. What is the project’s net present value? b. Kim expects the cash flows to be $3 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $2.2 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Kim is deciding whether to proceed with the hotel today or to wait a year to find out whether the tax will be imposed. If Kim waits a year, the initial investment will remain at $20 million. Assume that all cash flows are discounted at 13%. Use decision-tree analysis to determine whether Kim should proceed with the project today or wait a year before deciding.arrow_forwardA project under consideration has an internal rate of return of 16% and a beta of 0.9. The risk free rate is 6% and the expected rate of return on the market portfolio is 16%. A. What is the required rate of return? B. Should the project be accepted? C. What is the required rate of return on the project if it's beta is 1.90? D. If the projects beta is 1.90 should the project be accepted?arrow_forwardA project under consideration has an internal rate of return of 13% and a beta of 0.6. The risk-free rate is 8%, and the expected rate of return on the market portfolio is 13%. a. What is the required rate of return on the project? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. Should the project be accepted? Y/N c. What is the required rate of return on the project if its beta is 1.60? (Do not round intermediate calculations. Enter your answer as a whole percent.) d. If project's beta is 1.60, should the project be accepted? Y/Narrow_forward
- Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 14 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow −1,010 110 490 690 690 290 690 Use the payback decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice 4.00 years, reject 0 years, accept 2.59 years, reject 1.16 years, acceptarrow_forward30- If an investment is producing an internal rate of return that is equal to therequired return, the Net Present Value of the project will be ____ and theProfitability Index of the project will be ______. a. Negative; Greater than oneb. Negative; Onec. Zero; Oned. Positive; Onee. Positive; Greater than onef. Zero; Less than onearrow_forwardStandard deviation versus coefficient of variation as measures of risk Greengage, Inc., a successful nursery, is considering several expansion projects. All the alternatives promise to produce an acceptable return. Data on four possible projects appear in the following table: Project Expected return Range Standard deviation A 12.6% 5.7% 2.6% B 11.6% 6.2% 3.9% C 11.9% 5.9% 3.6% D 11.8% 6.1% 3.3% a. Which project is least risky, based on the range of possible outcomes? b. Which project has the lowest standard deviation? Explain why standard deviation may not be an entirely appropriate measure of risk for purposes of this comparison. c. Calculate the coefficient of variation for each project. Which project do you think Greengage's owners should choose?arrow_forward
- A project under consideration has an internal rate of return of 17% and a beta of 0.5. The risk-free rate is 9% and the expected rate of return on the market portfolio is 17%. A. What is the required rate of return on the project? B. Should the project be accepted? C. What is the required rate of return on the project if the beta is 1.50? D. If projects beta is 1.50, should the project be accepted?arrow_forwardProject X has an initial investment at time O of $1,000 and it returns $250 one year from now and$1,000 two years from now. Project Y has an initial investment at time O of $2,000 and it returns$2,534.40 two years from now. The risk level and the net present values of the two projects areequal. Calculate the required return for project X. Answer: 12% please do not solve with excelarrow_forwardYou estimate that a planned project for your company has a 0.3 chance of tripling the investment in a year and a 0.7 chance of halving the investment in a year. What is the standard deviation of the return on this project? A.1.5625 B.1.3126 C.1.2247 D.1.1457arrow_forward
- You are evaluating the following four projects: Project Beta Projected (or Expected) Return A 1.80 19.5% B 1.20 14.0% C 0.80 11.5% D 0.50 7.0% Your company’s current practice is to apply its WACC of 12% as a single hurdle rate to all projects. Under your company’s current practice, which project(s) of the four projects above would be incorrectly accepted? Currently, the 3-month Treasury bill rate is 3%, and the market risk premium is 10%. (Hint: Measure the RADRs using the CAPM.) Group of answer choices C A D B At least two of the projects are incorrectly accepted.arrow_forwardSuppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,150 30 570 770 770 370 770 Use the NPV decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice A. $968.66, accept B. $2,118.66, accept C. $-495.13, reject D. $864.87, acceptarrow_forwardStandard deviation versus coefficient of variation as measures of risk Greengage Inc., a successful nursery, is considering several expansion projects. All the alterna-tives promise to produce an acceptable return. Data on four possible projects follow. Project Expected return Range Standard deviationA 12.0% 4.0% 2.9% B 12.5 5.0 3.2 C 13.0 6.0 3.5 D 12.8 4.5 3.0 a. Which project is least risky, judging on the basis of range? b. Which project has the lowest standard deviation? Explain why standard deviation may not be an entirely appropriate measure of risk for purposes of this comparison.c. Calculate the coefficient of variation for each project. Which project do you think Greengage’s owners should choose? Explain why.arrow_forward
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