Determine the present value of store, Financial Management

Assignment Help:

Assume that ABC is considering opening an ice cream shop in Amsterdam. The shop will cost 1.8 million Euros, and the present value of the expected cash flows from the store is 1.4 million Euros. Thus, by itself, the shop has a negative NPV of  €0.4 million. Assume, however, that by opening this shop, ABC acquires the option to expand into a much larger ice cream and dessert shop any time over the next 5 years. The cost of expansion will be €4 million, and it will be undertaken only if the present value of the expected cash flows exceeds €5 million. At the moment, the present value of the expected cash flows from the expansion is believed to be only €4 million. If it were not, ABC would have opened the larger shop right away. ABC  still does not know much about the market for its ice cream and desserts in the Netherlands, and there is considerable uncertainty about this estimate: the annual standard deviation of the returns on the larger shop is 0.3. The risk-free interest rate is 3% per year. 

a) Construct the five-year price tree for the larger shop using Dt = 1 year.

b) Since ABC can open the larger shop at any time, determine the nodes in the tree that you constructed in part a) at which it is optimal to open the shop (we are assuming that the decision to open the shop will be discussed at ABC only once per year). Modify the tree to reflect the early exercise of the option.

c) Determine the present value of the option of opening the larger store. Does it make sense for ABC to invest in the loss-making, smaller shop now?


Related Discussions:- Determine the present value of store

Advantages of private mutual funds, Advantages of Private Mutual Funds ...

Advantages of Private Mutual Funds It is felt that the entry of private Mutual Funds would encourage competitiveness in the financial sector and promote the existing investment

Analyse the company capital structure, 1. Analyse the company's capital str...

1. Analyse the company's capital structure and critically assess different types of financing options available to the company. Calculate the cost of these different types of finan

The safety margin, Norfolk Ltd is specialized in producing & selling air co...

Norfolk Ltd is specialized in producing & selling air conditions.  In 2010, the manufacturing cost per unit included:

Finance, Ask questiSuggestion regarding Credit limit. Should it be approved...

Ask questiSuggestion regarding Credit limit. Should it be approved or not, what should be the amount of credit limit that electronics give to Booth Plastics.

Effective duration and convexity of callable bonds, The modified dura...

The modified duration is a measure of the sensitivity of a bond's price to interest rate changes; the assumption made here is that the expected cash flow does not

Define assumption behind experience approach to forecasting, What is the pr...

What is the primary assumption behind the experience approach to forecasting? The experience approach to forecasting is relies on the assumption that things will happen a fixed

Cost of capital, discuss the cost of capital in finance

discuss the cost of capital in finance

Calculate the present price of the stock, Company Z has just been organized...

Company Z has just been organized. It is expected to experience zero growth next year and grow at a 10% rate in year 2.  Beginning in the third year the company should attain a 5%

Maturity profile, Maturity Profile Even though there is no ideal theory...

Maturity Profile Even though there is no ideal theory/concept of the maturity of the instruments, some important issues that should be considered while balancing the long-term

Illustrate compound value concept, Q. Illustrate Compound Value Concept? ...

Q. Illustrate Compound Value Concept? The Compound Value Concept is used to find out the FV of present money. It is the same as the concept of compound interest, wherein the in

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd