C Corporation will generate cash flows of $300 million three years from today (without a...
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C Corporation will generate cash flows of $300 million three years from today (without a loss) or $100 million three years from today (with a loss). There is a 20% chance of a loss of $200 million in three years. The opportunity cost of capital is 10%. Ignore taxes.
i) Find the value today of the company under the following circumstances:
a) No insurance.
b) The company buys a no-load insurance policy today that will cover the potential loss.
c) The insurance policy has a load equal to 20% of the present value of the expected claim cost.
ii) Suppose that three years from today the company will be able to invest in a project that will cost $120 million then and generate cash flow of $130 million one year later.
a) Would the company accept the project three years from today if it had the money?
b) How much would this project be worth three years from today if it is accepted?
c) How low would the load on an insurance policy have to be to induce ABC Corporation to use insurance to guarantee that it could take this project?
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