Purchase Solution

Calculate NPV and Apply Black-Scholes Model

Not what you're looking for?

Ask Custom Question

Need help calculating the NPV and applying Black-Scholes model to estimate value of option. Please explain how to complete each step and calculate the answers.

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 that 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. While Kim expects the cash flows to be $3 million a year, it recognizes that the cash flows could, in fact, 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 1 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%. Using decision tree analysis, should Kim proceed with the project today or should it wait a year before deciding?
c. Use the Black-Scholes model to estimate the value of the option. (Hint: Assume the variance of the project's rate of return is 6.87% and the risk-free rate is 8%).

Purchase this Solution
Solution Summary

Need help calculating the NPV and applying Black-Scholes model to estimate value of option. Please explain how to complete each step and calculate the answers.

Solution provided by:
Manal Elkhoshkhany, MBA
Education
  • BA, Ain Shams University, Cairo Egypt
  • MBA, California State University, Sacramento
Recent Feedback
  • "ty i have more need help with"
  • "ty i have jmore i need help with"
  • "great help"
  • "excellent help"
  • "Very helpful and easy to understand."
Purchase this Solution
Free BrainMass Quizzes
Business Processes

This quiz is intended to help business students better understand business processes, including those related to manufacturing and marketing. The questions focus on terms used to describe business processes and marketing activities.

Business Ethics Awareness Strategy

This quiz is designed to assess your current ability for determining the characteristics of ethical behavior. It is essential that leaders, managers, and employees are able to distinguish between positive and negative ethical behavior. The quicker you assess a person's ethical tendency, the awareness empowers you to develop a strategy on how to interact with them.

Writing Business Plans

This quiz will test your understanding of how to write good business plans, the usual components of a good plan, purposes, terms, and writing style tips.

Operations Management

This quiz tests a student's knowledge about Operations Management

Transformational Leadership

This quiz covers the topic of transformational leadership. Specifically, this quiz covers the theories proposed by James MacGregor Burns and Bernard Bass. Students familiar with transformational leadership should easily be able to answer the questions detailed below.

View More Free Quizzes
Related BrainMass Solutions

  • Black Scholes

    Answer: $1,206,829 Uses the Black-Scholes model to calculate the value of the stock options.

  • Question about Value of Call Option using Black-Scholes model

    192746 Question about Value of Call Option using Black-Scholes model An analyst is interested in using the Black-Scholes model to value call options on the stock of Ledbetter Inc.

  • Black Scholes Merton Model

    357008 Black Scholes Merton Model A) Using the Black-Scholes-Merton model, calculate the price of a call and put given a market price of the underlying stock of $83, the exercise price of $85, 65 days to expiration, a risk-free rate of 4.5 percent,

  • Black Scholes: value of a call option on Kellogg

    on the Kellogg Company, and the ten year average annual return on 10-year treasury constant maturity rate bonds and applying the Black-Scholes option pricing model, the value of a call option on Kellogg stock with a given exercise price and maturity

  • Black Scholes Model - Value of a call option

    (-r*t) 0.98511194 N(d1) 0.705061952 N(d2) 0.669674827 pdf(d1) 0.345001195 pdf(d2) 0.362291608 BLACK SCHOLES PRICE =2.020423216 Answer A This solution illustrates how to calculate the value of a call option using black scholes model.

  • Option Pricing Followup Questions

    The Black-Scholes Option Pricing Model. - What is the Black-Scholes option-pricing model? - How do you apply the Black-Scholes option-pricing model? - What is historical volatility? - How do you find implied volatility?

  • Purcell Industries: Black Scholes Option Pricing Model

    Using the Black-Scholes Option Pricing Model, the value of option is V = P[N(d1)] - Xe−rRFt [N(d2)] = $15(0.59675) - $15e(-0.06)(0.5)(0.50000) = $8.95128 - $15(0.9512)(0.50000) = $1.6729 The solution explains concisely how to calculate the

  • Black-Scholes Option Pricing Model

    Given this information, the analyst is then able to calculate some other necessary components of the Black-Scholes model: d1=0.34177 d2=0.12964 N(d1)=0.63369 N(d2)=0.55155 N(d1) and N(d2), represent areas under a standard normal distribution

  • Applying the Black-Scholes Model

    Solution describes the steps to calculate value of call option by using Black Scholes model.

View More Related Solutions