I am having problems solving this question. I would appreciate if someone can gi
ID: 2775032 • Letter: I
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I am having problems solving this question. I would appreciate if someone can give me the complete step by step solution so I can learn from it. STEP by STEP solution !!
Teekay LNG Patners L.P. is considering whether to add onboard regasification capacity to their LNG tanker fleet. Such capacity would enable the ships to fimction not only as modes of transport, but also as regasification platfoms. Reverue from regasifying natural gas will be collected from destination countries, enhancing the comparry's anmal cash flows. The cost of adding regasification capacity is $160 million per tanker (disregard any time lag that typically accompanies regas installation). The company currently owns 29 LNG camiers that canoperate forever (for simplicity). Curently Teekay generates $150 million per year from the transportation side of its LNG shipping business. If regasification capacity is added this year, the expected amual cash flows will be $405 million per year, including this year (i.e. assuming that adding regasification capacity is almost instantaneous andincreases revenue right away). Teekay's cost ofcapitalis 10%. The risk-free rate in the market is 2%. Calculate the value of Teekay's LNG fleet with and withoutregasification capacity thisyear a. b. Should Teekay invest in regasification capacity forits fleet of LNG tankers this year? Global demand for LNG can change dramatically over the next year. If Teekay does not invest in regasification capacity this year, but instead decides to invest in regasification capacity nextyear: if LNG demand grows next year, Teekay will invest in regasification capacity and the expected cash flows will increase to S600; if the demand falls, Teekay will not invest in regasification and its cash flows will remain at $150 million dollars per ear c. If Teekay invests in regasification capacity nextyear, when the demandfor LNG is knownto grow, what will be the expectedvalue ofits LNG fleet thisyear? d. Whatis the value ofthe real option to delayinvestment inregasificationcapacity?Explanation / Answer
Answer:a If the firm invests in regasification capacity this year, the cash flows are:
t=0: $150 m
t=1: $150 m
t=2: $150 m
t=3: $150 m …
So NPV= 150 +150/10%= $1650m
(PV of the cash flows starting from t=1 is a perpetuity; r=10%)
If the firm invests in regasification capacity this year, the cash flows are:
t=0: -160m* 29 + 405 m
t=1: 405 m
t=2: 405 m
t=3: 405 m …
So NPV= -160*29 +405 +405/10%= -185 m
Answer:b Given that the NPV is negative. So the firm should NOT invest in regasification capacity this year.
Answer:c If the firm has the option not to invest in this year, but to decide to invest next year when the demand for natural gas is high, then the cash flows are:
t=0: 150 m
t=1: -160m* 29 + 600 m
t=2: 600 m
t=3: 600 m …
So NPV= 150+(-160*29)/(1+10%) +600/10%= 1931.8 m
Answer:d If the firm has no such real option of delaying investment in next year, then the firm will not invest in this year, the NPV= $1650.
With the real option to invest next year when the demand for natural gas is high, the NPV=$1931.8m.
SO the value of the real option is 1931.8-1650= $281.8 m
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