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    Expected net present value of the project and Real option

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    Question 3. Kanga Resorts is interested in developing a new facility in Asia. The company estimates that the hotel would require an initial investment of $14 million. The company expects that the facility will produce positive cash flows of $2.6 million a year at the end of each of the next 10 years. The project's cost of capitl is 12%.

    a. Calculate the expected net present value of the project.

    b. The compaqny recognizes that the cash flows could, in fact, be much higher or lower than $2.6 million, depending on whether the host government imposes a large facility tax. One year from now, the company will know whether the tax will be imposed. There is a 40 percent chance that the tax will the imposed, in which case the yearly cash flows will be only $2 million. At the same time, there is a 60 percent chance that the tax will not be imposed, in which case the yearly cash flows will be $3 million. The company is deciding whether to proceed with the facility today or to wait 1 year to find out whether the tax will be imposed. If it waits year, the initial investment will remain at $14 million. Assume that all cash flows are discounted at 12 percent. Using decision tree analysis, calculate the value of the real option to wait a year before deciding.

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    Solution Preview

    Question 3. Kanga Resorts is interested in developing a new facility in Asia. The company estimates that the hotel would require an initial investment of $14 million. The company expects that the facility will produce positive cash flows of $2.6 million a year at the end of each of the next 10 years. The project's cost of ...

    Solution Summary

    This provides the steps to calculate the expected net present value of the project and value of real option

    $2.49

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