Use a Binomial Tree to Value to Following Option

question 21

Multiple Choice

Use a binomial tree to value to following option. Assume r_f = 0.045, r_p = 0.14, σ = 0.20, E(CF₁) = $62 million, g = 0.03, time horizon = 2 years, binomial period = 1 year, and cost = $500 million. What is the value of this project option?

• A) $47 million
• B) $57 million
• C) $67 million
• D) $77 million

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Definitions:

Financial Break-even Point

It is the level of revenue necessary to cover a company’s fixed and variable costs, without generating profit or loss.

Degree of Operating Leverage

A financial metric that measures the sensitivity of a company's operating income to changes in its sales, highlighting the effect of fixed costs on profits.

Conventional Cash Flows

Conventional cash flows involve an initial outlay followed by a series of positive cash inflows, typically seen in standard investment scenarios.

Marginal Cost

The additional cost incurred in producing one more unit of a product or service, critical for making production decisions.