Homework answers / question archive / You have been asked to graphically illustrate a specific option to alter production by drawing its payoff diagram

You have been asked to graphically illustrate a specific option to alter production by drawing its payoff diagram

Finance

Share With

---

You have been asked to graphically illustrate a specific option to alter production by

drawing its payoff diagram. It relates to an industrial beer fermenter that can also be

adapted to be used to ferment wine if the company chooses to switch from beer to wine

production. This specific fermenter cost $100,000 initially to buy, which was $30,000

more than a fermenter that could only ferment beer. If the firm chooses to switch

production, it will cost the firm $60,000 to re-format the machine so that it is able to

ferment wine.

 

Currently, the present value of the future cash flows associated with beer production is

$450,000, while the present value of future cash flows associated with wine production

is $410,000 (excluding any costs associated with reformatting the machine).

 

 

Draw the profit diagram for the option described above. Label all axes, intercepts and

turning points. Also indicate on the diagram with the letter "A" what current market

conditions indicate about what the current profit and "moneyness" of the option

described above.