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.

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.

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 1P: Talbot Industries is considering launching a new product. The new manufacturing equipment will cost...

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Talbot 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?
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