Exam 22: Real Options

Use the following information to answer the question(s)below. Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate)is 7.65%. -Assuming that this project will provide Rearden with perpetual annual cash flows of $65,000,the NPV of investing in the project today is closest to:

Use the table for the question(s)below. Consider the following mutually exclusive projects: -Using the equivalent annual benefit method,which project would you select and why?

Assume the NPV of a project is $1.5 million.The project is expected to last five years.What is the equivalent annual benefit if the discount rate is 8%?

The constant annuity payment over the life of a project that is equivalent to receiving the NPV today is the: