The owner of a pro football team expects the team to be worth either $270 million next year or $120 million, depending on whether or not she gets the city to build a new stadium. There is a 60% chance she will get a new stadium. There is a buyer willing to pay $175 million for the team, but will not keep the offer open without some form of compensation. Given a discount rate of 7%, how much should she be willing to pay for the option to sell the team?
A) 0
B) $21 million
C) $42 million
D) $55 million

Question

Quizplus · Accepted Answer

The value of the option is the difference between the expected value of the team with the option and the expected value of the team without the option. The expected value of the team with the option is:(0.6 * $270 million) + (0.4 * $120 million) = $180 millionThe expected value of the team without the option is:(0.6 * $175 million) + (0.4 * $120 million) = $159 millionTherefore, the value of the option is:$180 million - $159 million = $21 million

The Owner of a Pro Football Team Expects the Team