The Mark II investment is double the scale of the Mark I (note the expected rapi
ID: 2645923 • Letter: T
Question
The Mark II investment is double the scale of the Mark I (note the expected rapid growth of the industry). Investment required is $995 million (the exercise price), which is taken as fixed.
Forecasted cash inflows of the Mark II are also double those of the Mark I, with present value of $902 million in 1985 and 902/(1.2)3 = $522 million in 1982.
The future value of the Mark II cash flows is highly uncertain. This value evolves as a stock price does with a standard deviation of 43% per year. (Many high-technology stocks have standard deviations higher than 43%.)
How does the value in 1982 of the option to invest in the Mark II change if the investment required for the Mark II is $895 million (vs. $995 million)?(Enter your answer in millions. Do not round intermediate calculations. Round your answer to 2 decimal places.)
How does the value in 1982 of the option to invest in the Mark II change if the present value of the Mark II in 1982 is $595 million (vs. $522 million)? (Enter your answer in millions. Do not round intermediate calculations. Round your answer to 2 decimal places.)
How does the value in 1982 of the option to invest in the Mark II change if the standard deviation of the Mark II
Use the following assumptions for valuing the option to invest in the Mark ll microcomputer. 1. The decision to invest in the Mark II must be made after three years, in 1985. 2.The Mark II investment is double the scale of the Mark I (note the expected rapid growth of the industry). Investment required is $995 million (the exercise price), which is taken as fixed.
3.Forecasted cash inflows of the Mark II are also double those of the Mark I, with present value of $902 million in 1985 and 902/(1.2)3 = $522 million in 1982.
4.The future value of the Mark II cash flows is highly uncertain. This value evolves as a stock price does with a standard deviation of 43% per year. (Many high-technology stocks have standard deviations higher than 43%.)
5. The annual interest rate is 8%.Explanation / Answer
Investment required (the exercise price)=K= $995 million
P.V of Cash flow in 1982(Spot Price) =S=$522 million
s.d=43%
Rate=8%
d1 = ( ln(S/K) + (r + (s.d2/2))t ) / s.d?t=0.182262
d2 = d1
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