Assume that it will cost you $1 million to shut down the plant,but you are able to sell the plant for $5 million at any time.The value of the option to sell the plant will be closest to:
A)$3.0 million
B)$6.0 million
C)$5.0 million
D)$0.5 million

Question

Quizplus · Accepted Answer

A)Value if revenues increase
V = 11ea7cce_3c66_0eb8_928c_0bc29541bf8e_TB1626_11 = $8 million
Value if revenue decreases
V = 11ea7cce_3c66_35c9_928c_9d2ff97122d2_TB1626_11 = -$1 million,
however if you could sell the plant you would receive $5 million
Value with embedded option
V = (.5)($8)+ (.5)($5)= $6.5 million
Value without embedded option
V = (.5)($8)+ (.5)(-$1)= $3.5 million
So,the option to sell the plant is worth $6.5 million - $3.5 million = $3.0 million

Assume That It Will Cost You $1 Million to Shut