Reference no: EM131478527

Pegasus Inc. wants to estimate the present value of project X. All production and sales take place one year from now, and there is no option to shut down production. Project X will produce 50 (million) widgets in all states of the world. The price of widgets next year will depend upon demand conditions. If demand is high, each widget will sell for $200. If demand is low, each widget will sell for $100. There are two inputs into the production process: labor and oil. Labor costs at time 1 are equal to $20 per widget. The folks over in production indicate that each widget produced requires one barrel of oil at time 1. The folks over in marketing and sales indicate that the performance of the stock market is a perfect predictor of demand for widgets, i.e., the demand for widgets is high when the market return is high. You have been asked to value the project. The following pieces of information may be useful to you.

There are no taxes. The historical equity beta for Pegasus is 1.2. Pegasus has historically maintained a debt to equity ratio of 1/2. The spot price of oil one year from now will be either $50 or $40 depending on condition of world oil markets. The forward price for barrel of oil, deliverable one year from now, is $45. One unit of the (market) S&P 500 index can be purchased for $1000 today. The S&P will be worth either $1500 or $900 next year. The risk-free rate is 5%. The historical average return on the market portfolio is 12%. What is the most you would be willing to pay for the rights to the project?