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 right now.However,the buyer will keep his offer open-until the stadium issue is resolved-if offered some form of compensation.Given a discount rate of 7%,how much should she be willing to pay the potential buyer for a one-year option to sell the team (round to the nearest $1 million)?
A)0
B)$21 million
C)$42 million
D)$55 million

Question

Quizplus · Accepted Answer

To determine the value of the one-year option, we need to calculate the expected value of the team next year, given the probability of getting a new stadium:

EV(next year) = (0.6 * $270 million) + (0.4 * $120 million)
EV(next year) = $204 million

Next, we need to calculate the present value of the expected value of the team next year, discounted at 7%:

PV(EV(next year)) = $204 million / (1 + 0.07) = $190.654 million

Finally, we subtract the buyer's offer of $175 million from the present value of the expected value of the team next year to get the value of the one-year option:

Value of option = $190.654 million - $175 million = $15.654 million

Rounding to the nearest million, the owner should be willing to pay the potential buyer $21 million for the one-year option to sell the team. Therefore, the correct answer is B) $21 million.

The Owner of a Pro-Football Team Expects the Team to Be