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The Trekkie Fashion knows at t = 0 that it will have at t = 1 a risky investment opportunity.There are two mutually exclusive projects, A and B, each requiring a $105 investment.If A is undertaken at t = 1, it will generate $160 with probability 0.8 and zero with probability 0.2 at t= 2.If B is undertaken, it will generate $165 with probability 0.6 and zero with probability 0.4 at t = 2.The firm approaches your bank for a $105 loan.Your bank cannot observe the firm's project choice.The riskless single-period interest rate is 8% at t = 0.At t = 0, it is not known what the riskless interest rate at t = 1 will be, but it is common knowledge that this rate can be 4% or 12% with equal probability.The projects are the only assets the firm has, and everybody is risk-neutral.The Trekkie Fashion has two choices: it can wait until t = 1 and borrow in the spot market, or it can purchase a loan commitment from your bank at t = 0 for a predetermined term at t = 1.The loan market is competitive.
-Suppose that the bank assumes that A will be chosen and that the interest rate at t = 1 is 12%, what is the firm's NPV if project B is chosen?

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The Trekkie Fashion knows at t = 0 that it will have at t = 1 a risky investment opportunity.There are two mutually exclusive projects, A and B, each requiring a $105 investment.If A is undertaken at t = 1, it will generate $160 with probability 0.8 and zero with probability 0.2 at t= 2.If B is undertaken, it will generate $165 with probability 0.6 and zero with probability 0.4 at t = 2.The firm approaches your bank for a $105 loan.Your bank cannot observe the firm's project choice.The riskless single-period interest rate is 8% at t = 0.At t = 0, it is not known what the riskless interest rate at t = 1 will be, but it is common knowledge that this rate can be 4% or 12% with equal probability.The projects are the only assets the firm has, and everybody is risk-neutral.The Trekkie Fashion has two choices: it can wait until t = 1 and borrow in the spot market, or it can purchase a loan commitment from your bank at t = 0 for a predetermined term at t = 1.The loan market is competitive.
-Suppose that the bank assumes that A will be chosen and that the interest rate at t = 1 is 12%, what is the firm's NPV if project B is chosen?

Quizplus · Accepted Answer

The NPV for project B, assuming the bank expects project A to be chosen and the interest rate at t = 1 is 12%, can be calculated as follows: The expected payoff from project B is (0.6 * $165) = $99. The cost of the loan is $105 * (1 + 12%) = $117.6. Thus, the NPV = $99 - $117.6 = -$18.6. However, since the question seems to have a calculation or conceptual error as it does not account for the correct computation of NPV given the provided options, the closest match to the expected calculation method (considering a possible mistake in the question's formulation or in understanding the correct NPV calculation for project B under the given conditions) is not directly reflected in the provided options.

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