Question

this question is a variant of the sport hotel example that was presented in class, in the class notes, and in the real option chapter. the change to consider is this: suppose that the value of the hotel is one of two values: $9.4 million if the city is successful in obtaining the franchise (and not $8 million as in the original problem) or $3.8 if the city is not successful in obtaining the franchise (and not $2 million as in the original problem). all other aspects of the problem are the same as originally presented, such as the costs per year. assume that the probability of obtaining the franchise is 50%. incorporating these new hotel values from above, and the real option, what is the new npv of the project?

Answer 1

The new NPV of the project is $5.6 million.

To calculate the new NPV of the project, we need to consider the two possible values for the hotel:

• If the city is successful in obtaining the franchise, the value of the hotel is $9.4 million.
• If the city is not successful in obtaining the franchise, the value of the hotel is $3.8 million.

Since the probability of obtaining the franchise is 50%, we can calculate the expected value of the hotel by taking the average of the two possible values:

Expected value = (0.5 * $9.4 million) + (0.5 * $3.8 million) = $6.6 million

To calculate the new NPV, we subtract the initial investment of $1 million from the expected value:

New NPV = $6.6 million - $1 million = $5.6 million