Let the present value from production be equal to V = 100, and this value can move either up (with factor u = 1.5) or down (with factor d = 1/u) per period. Suppose that at t=3 management has the option to invest 90 million in order to double the value of production. The risk free rate is 2%. What is the expanded present value of this production facility if management has the opportunity to expand at t = 3
| V=100 | |||||||||
| Factor u = 1.5 | |||||||||
| Up value = 100*1.5 | 150 | ||||||||
| Down value = 100/1.5 | 66.66667 | ||||||||
| Risk free = 2% | |||||||||
| P(u) | (100*1.02 - 66.67)/ (150-66.667) | ||||||||
| 42% | |||||||||
| P(D) | 1-0.42 | ||||||||
| 58% | |||||||||
| At t=3 management has the option to invest 90 million in order to double the value of production | |||||||||
| Present value = | |||||||||
| DF@2% for T=3 | 0.942322 | 90 | 84.80901 | ||||||
| Present value is 84.81 | |||||||||
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