Reference no: EM132509926

Intel is developing a new computer chip and wants to use the buses made by your company, Rambus Inc. However, it will take Intel 1-year to develop the chip. If the market demand for these chips is high, Intel expects to sell 35 million chips. Unfortunately, there is a competing technology currently in the works that might make this chip obsolete in which case Intel will scrap the chip entirely (i.e., sell 0). You are in the business of producing these buses and your cost is $3.50 each (your production time is 1 year and the entire cost of $3.50 per chip is sunk today). Because Intel wants to be certain about production costs, Intel wants to set the delivery price today at $6 per bus. If Intel does not buy the buses (i.e., if the competing technology succeeds) you will sell them on the open market, but at a low price of $3 each. If the competing technology does not work, your buses will be in huge demand and sell for $7 each on the open market. Assume that this risk implies a discount rate of 25%. Thus, based on the discount rate and after applying certain probabilities for two possible market conditions you estimate the price for your bus is worth $4.80 today. Intel offers Rambus a fee for entering into this agreement. How much should Rambus charge Intel for guaranteeing the buses at $6 each? Assume the one-year government bond yield is 6%? (Hint: Rambus' product buses are the underlying asset for a call option contract and price per unit at current value is $4.80. Rambus is selling the call with exercise price $6 per unit. The question is asking the price for call option.)