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

question 33

Multiple Choice

Use the following information to answer the question(s) below.

Rearden Metal imports ore from South America. Assume that it is 2016 and Rearden Metal is worried that the South American mines may enter into a long-term contract with the Chinese to sell all of their ore output to China, hence cutting off Rearden Metal's supply. In the event of such a contract with the Chinese, Rearden Metal will face much higher costs for its raw materials causing its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% down to 10%. An insurance firm has agreed to write a trade insurance policy that will pay Rearden Metal $2,500,000 in the event of the South American supply of ore being cut off. The chance of the South American supply being cut off is estimated to be 20%, with a beta of -2.0. The risk-free rate of interest is 4% and the return on the market is estimated to be 12%.

-Rearden's NPV for purchasing this policy is closest to:

• A)$32,500.
• B)$56,750.
• C)$142,000.
• D)$156,250.

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Definitions:

Useful Life

The estimated duration a fixed asset is expected to be economically usable, with normal repairs and maintenance, for its intended purpose.

Cash Payback Period

The duration it takes for an investment to generate an amount of cash equal to the initial investment cost.

Salvage Value

The estimated residual value of an asset at the end of its useful life, representing what it could be sold for or its scrap value.

Straight-Line

A depreciation method that equally spreads the cost of an asset over its useful life.