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5. A boutique has an expansion plan in which one of the following options can be chosen: . . Expand immediately at $640,000. Expand one year later at $680,000, to be paid at that time; Expand two years later at $750,000, to be paid at that time. Do not expand; nothing has to be paid. . The value of the expanded business is estimated at $800,000 now. The boutique mod- els that this value can grow at 25% per year or decrease at 20% per year in each of the next two years. The risk-free effective interest rate is 5% per annum. (a) Using a two-period binomial tree, calculate the value of the flexibility to delay the expansion plan via the risk-neutral valuation method. [7 marks] (b) Using the binomial tree in part (a), calculate the drop in the value of the flexibility if it is only possible to delay the expansion plan by two years, not by one year. [3 marks] [Total: 10 marks] 5. A boutique has an expansion plan in which one of the following options can be chosen: . . Expand immediately at $640,000. Expand one year later at $680,000, to be paid at that time; Expand two years later at $750,000, to be paid at that time. Do not expand; nothing has to be paid. . The value of the expanded business is estimated at $800,000 now. The boutique mod- els that this value can grow at 25% per year or decrease at 20% per year in each of the next two years. The risk-free effective interest rate is 5% per annum. (a) Using a two-period binomial tree, calculate the value of the flexibility to delay the expansion plan via the risk-neutral valuation method. [7 marks] (b) Using the binomial tree in part (a), calculate the drop in the value of the flexibility if it is only possible to delay the expansion plan by two years, not by one year. [3 marks] [Total: 10 marks]

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