Use the Following Information to Answer the Question(s)below

question 37

Multiple Choice

Use the following information to answer the question(s) below.
Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate) is 7.65%.
-Assuming that this project will provide Rearden with perpetual annual cash flows of $55,000,the NPV of investing in the project today using the hurdle rate is closest to:

• A)-$281,000.
• B)-$150,000.
• C)-$83,000.
• D)+$83,000.
• E)+$281,000.

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Definitions:

Money Spread

The difference between two prices or rates, often used to describe the gap between bid and ask prices in financial markets.

Call Option

A financial contract that gives the holder the right, but not the obligation, to buy a stock, bond, commodity, or other assets at a predetermined price within a set time frame.

Covered Call

An options strategy where an investor holds a long position in an asset and sells call options on that same asset to generate income from the option premiums.

Exchange-Traded Options

Options contracts that are traded on a regulated exchange rather than being dealt with privately between two parties.