Answered » You can buy a ready-made answer or pick a professional tutor to order an original one.
An entrepreneur recently learned about a new hotel business that requires an initial investment of $12M and annual cash flow of $2M in perpetuity. The appropriate discount rate is 20%. Now, consider a pretty similar scenario: an Initial investment $12M. Now, in good state, $6M annual cash flows. In a bad state, -$2M annual cash flows. Furthermore, assume that the entrepreneur wants to own at most, 1 hotel (no option to expand). – But things change when we consider the abandonment option. At date 1, the entrepreneur will know which forecast has come true. If the world is in the good state, he will keep the project alive. If bad state, he will abandon the hotel after period 1. – Now, what is the NPV of the project? – What is the value of the option to abandon?
An entrepreneur recently learned about a new hotel business that requires an initial investment of $12M and annual cash flow of $2M in perpetuity. The appropriate discount rate is 20%. Now, consider a pretty similar scenario: an Initial investment $12M. Now, in good state, $6M annual cash flows. In a bad state, -$2M annual cash flows. Furthermore, assume that the entrepreneur wants to own at most, 1 hotel (no option to expand). – But things change when we consider the abandonment option. At date 1, the entrepreneur will know which forecast has come true. If the world is in the good state, he will keep the project alive. If bad state, he will abandon the hotel after period 1. – Now, what is the NPV of the project? – What is the value of the option to abandon?
