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Consider a two-period investment project.
The following table describes the cash flows and the comparison stock prices in time 0
and time 1.
In addition, if there is a boom in the first time period, the present value of cash flows in
time 2 (but measured at time 1) is $102,000 and if there is a recession in the first time
period, the present value of cash flows in time 2 (but measured at time 1) is $80,000.
(a) Using the ARBITRAGE PROCEDURE, what is the net-present value of this project?
Should the investment project go ahead?
(b) How would your answer to part (a) change if an outside investor were to offer
$50,000 for 50% ownership of the project at the end of time period 1?
(c) What is the minimum offer that the company would be prepared to accept from an
outside investor for 50% ownership of the project at the end of time period 1?
Period Economic state Project CF current -$150,000 recession 80,000 boom 105,000 Risk free rate NA 8% 8% Comparison Stock price $10.00 9.50 12.00 Period Economic state Project CF current -$150,000 recession 80,000 boom 105,000 Risk free rate NA 8% 8% Comparison Stock price $10.00 9.50 12.00
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