A Firm Is Considering Investing in a New Project with an Upfront

question 11

Multiple Choice

A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 12%, what is the value of this project?

• A) $155.6 million
• B) $555.6 million
• C) $583.3 million
• D) $183.3 million

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Definitions:

Call Option Contracts

Financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period.

Strike Price

The fixed price at which the owner of an option can purchase (call) or sell (put) the underlying asset.

Option Price

Option price refers to the premium that must be paid to buy an option, which grants the holder the right, but not the obligation, to buy or sell an underlying asset at a set price.

Risk-Free Rate

The rate of return on an investment with no risk of financial loss.