Luther Industries Is Considering Launching a New Toy Just in Time

question 56

Essay

Luther Industries is considering launching a new toy just in time for the Christmas season.They estimate that if Luther launches the new toy this year it will have an NPV of $25 million.Luther has the option to wait one year until the next Christmas season to launch the toy,however,the demand next year will depend upon what new toys Luther's competitors introduce and therefore greater uncertainty about next years demand.Launching the new today will involve a total capital expenditure of $100 million.If the risk-free rate is 5%,N(d₁)is .62 and N(d₂)is .65,then what is the value of the option to wait until next year to launch the new toy?

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Definitions:

Relative Change

The measure of change in a variable relative to its initial value, often expressed as a percentage.

Inelastic

Describes a situation where the quantity demanded or supplied of a good or service changes by a relatively small amount in response to changes in its price.

Quantity Demanded

The amount of a product or service consumers are willing and able to buy at a given price over a specified period of time.

Unit Elasticity

Demand or supply for which the elasticity coefficient is equal to 1; means that the percentage change in the quantity demanded or quantity supplied is equal to the percentage change in price.