Determine the present value of store, Financial Management

Assume that ABC is considering opening an ice cream shop in Amsterdam. The shop will cost 1.8 million Euros, and the present value of the expected cash flows from the store is 1.4 million Euros. Thus, by itself, the shop has a negative NPV of  €0.4 million. Assume, however, that by opening this shop, ABC acquires the option to expand into a much larger ice cream and dessert shop any time over the next 5 years. The cost of expansion will be €4 million, and it will be undertaken only if the present value of the expected cash flows exceeds €5 million. At the moment, the present value of the expected cash flows from the expansion is believed to be only €4 million. If it were not, ABC would have opened the larger shop right away. ABC  still does not know much about the market for its ice cream and desserts in the Netherlands, and there is considerable uncertainty about this estimate: the annual standard deviation of the returns on the larger shop is 0.3. The risk-free interest rate is 3% per year. 

a) Construct the five-year price tree for the larger shop using Dt = 1 year.

b) Since ABC can open the larger shop at any time, determine the nodes in the tree that you constructed in part a) at which it is optimal to open the shop (we are assuming that the decision to open the shop will be discussed at ABC only once per year). Modify the tree to reflect the early exercise of the option.

c) Determine the present value of the option of opening the larger store. Does it make sense for ABC to invest in the loss-making, smaller shop now?

Posted Date: 3/2/2013 7:15:20 AM | Location : United States







Related Discussions:- Determine the present value of store, Assignment Help, Ask Question on Determine the present value of store, Get Answer, Expert's Help, Determine the present value of store Discussions

Write discussion on Determine the present value of store
Your posts are moderated
Related Questions
Normally, the cash flows from mortgage backed and assets-backed securities are obtained on monthly basis. Therefore, the yield calculated would be on a monthly ba

A 10-year, 12% semi-yearly coupon bond with a par value of $1,000 may be called in 4 years at a call price of $1,050. The bond sells for $1,050. (Suppose that the bond has just bee

Ask questionSally Thomson #Minimum 100 words accepted#

Assembling the Divestiture Team: Divestment of a business requires a team of functional experts under the direction of an experienced project manager. The first and foremost ac

State about the Quick ratio or acid test Quick ratio = Current assets less inventories /Current liabilities(times) This  ratio  measures  immediate  solvency  of  a  busin

what is the meaning of market feasibility? What are its different types with their degree?

Fundamental ingredients of Management of working capital Management of working capital has two fundamental ingredients: (1) an overview of working capital management as a wh

Explain about the liquidity premium theory of the term structure of interest rates. Liquidity premium theory: Liquidity premium theory asserts which, into a world of unce

A manager must be able to quantify as to what will result from an adverse change in interest rates to control interest rate risk. Different types of valuation mode

The effective maturity of a callable bond can be anywhere between the first call date and its maturity date due to the presence of the call feat