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You are considering whether you should invest $12 million at time 0 for the following...

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Finance

You are considering whether you should invest $12 million at time 0 for the following project. Suppose there will be zero net cash flow during the first year. The net cash flows for the second year onwards will depend on the weather in the first year. Their discounted value at time 1 (i.e., the end of the first year) will be $18 million if weather is good in the first year (probability=0.5). Their discounted value at time 1 will be $8 million if weather is bad in the first year (probability=0.5). However, you can choose to sell off the project for $11 million at time 1. The discount rate suitable for the whole project is 8.33% per year. Calculate the value of the abandonment option using the decision tree method.

a. $0.99 million b. $1.15 million c. $1.23 million d. $1.30 million e. $1.38 million

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