plz write down very specific solution and I will give a good rate. A company is
ID: 1136680 • Letter: P
Question
plz write down very specific solution and I will give a good rate.
A company is deciding whether or not to purchase a piece of land that it could develop into a shopping centre some time in the next 12 years. The land is on sale for $5,000,000. The cost of building the shopping centre is $78,000,000, not counting the purchase price for the land. The risk free rate is 0.04. The company added a risk premium of 0.16 to obtain a discount rate for calculating the present value of future revenues over the lifetime of the shopping centre of 0.2. Using this discount rate they determined that the present value of the revenue for the shopping is $70,000,000 so using NPV it is not currently worth building the shopping centre. However the company wishes to perform a real options analysis to determine if it is worth purchasing the land now for the option to build the shopping centre later. It expects the present value of the revenue to have an annual volatility of 0.44. It will use a binomial lattice covering a period of 12 years using a total of 24 time steps to decide if it is worth purchasing the land So far they have determined the values of u and d for the binomial lattice given below. What are the values that they should use for P(u) and P(d)? (Answer to 3 decimal places.) .364963 P(u) 0.732621 P(d)Explanation / Answer
Formula to calculate Probability in Binomial Pricing model is
p=exp(-rt)-d/(u-d)
exp(-rt)=exp(-0.2*0.5)=0.904837
As t=0.5 because we are going to form 24 steps lattice for 12 years
p=(0.904837-0.732621)/(1.364963-0.732621)=0.272346...Probability for upward movement
and q=(1-p)=0.727654...Probability for downward movement
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