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You own a small manufacturing plant that currently generates revenues of $2 million per year

Accounting

You own a small manufacturing plant that currently generates revenues of $2 million per year.  Next year, based upon a decision on a long-term government contract, your revenues will either increase by 20% or decrease by 25%, with equal probability, and stay at that level as long as you operate the plant.  Other costs run $1.6 million dollars per year. You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.

 

1) If you are awarded the government contract and your sales increase by 20%, then the value of your plant will be closest to:

A) $5 million

B) $8 million

C) $0

D) $4 million

2) If you are not awarded the government contract and your sales decrease by 25%, then the value of your plant will be closest to:

A) -$1 million

B) $5 million

C) $8 million

D) $0

 

3) Given the embedded option to sell the plant, the value of your plant will be closest to:

A) $5.0 million

B) $4.0 million

C) $6.5 million

D) $8.0 million

 

4) Assume that you are not able to sell the plant, but you are able to shut down the plant at no cost at any time.  Given the embedded option to abandon production the value of your plant will be closest to:

A) $8.0 million

B) $4.0 million

C) $5.0 million

D) $6.5 million

 

5) Assume that you are not able to sell the plant, but you are able to shut down the plant at no cost at any time.  The value of the option to abandon production will be closest to:

A) $1.0 million

B) $0.5 million

C) -$1.0 million

D) $3.0 million

 

6) 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

 

7) Assuming you are able to see the plant, draw a decision tree detailing this problem.

8) Assume that you are not able to sell the plant, but you are able to shut down the plant at no cost at any time.  Draw a decision tree detailing this problem.

 

 

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