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(18 marks) a) The current price of Kinston Corporation stock is $12. In each of the next two years, this stock price can either go up by 30% or go down by 30%. Kinston stock pays no dividends. The one year risk-free interest rate is 5% and will remain constant. Draw the binomial pricing model and calculate the price of a two-year put option on Kinston stock with a strike price of $11. (10 marks) b) Your company is considering a new project at a cost of $10 million. The project may begin today or in exactly one year. You expect the project to generate $2 million in free cash flow the first year if you begin the project today. Free cash flow is expected to grow at a rate of 3% per year forever. The appropriate cost of capital for this investment is 15%. The risk-free rate is 5%. The standard deviation of the project is 30%. Should you begin the project today or wait one year? (8 marks) (18 marks) a) The current price of Kinston Corporation stock is $12. In each of the next two years, this stock price can either go up by 30% or go down by 30%. Kinston stock pays no dividends. The one year risk-free interest rate is 5% and will remain constant. Draw the binomial pricing model and calculate the price of a two-year put option on Kinston stock with a strike price of $11. (10 marks) b) Your company is considering a new project at a cost of $10 million. The project may begin today or in exactly one year. You expect the project to generate $2 million in free cash flow the first year if you begin the project today. Free cash flow is expected to grow at a rate of 3% per year forever. The appropriate cost of capital for this investment is 15%. The risk-free rate is 5%. The standard deviation of the project is 30%. Should you begin the project today or wait one year? (8 marks)

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