I will thumbs up correct answerr. The Webber Company is an international conglom
ID: 2657214 • Letter: I
Question
I will thumbs up correct answerr.
The Webber Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $17 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $16 million today. If demand increases, the building would be worth $18.2 million a year from today. If demand decreases, the same office building would be worth only $15 million in a year. The company can borrow and lend at the risk-free annual effective rate of 7 percent. A local competitor in the real estate business has recently offered $624,000 for the right to build an office building on the land What is the value today of the right to build the office building? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Value of rightExplanation / Answer
Rise= ($18,200,000 – 16,000,000) / $16,000,000
Rise= .1375 or 13.75%
Fall= ($15,000,000 – 16,000,000) / $16,000,000
Fall= –.0625 or –6.25%
Strike price= 17,000,000
Value of real call option with a strike of $17,000,000
C+=Max(0, $18,200,000 – 17,000,000) = 1,200,000.
C- = =Max(0, $$15,000,000 – 17,000,000) = 0
Risk free rate = (ProbabilityRise)(ReturnRise) + (ProbabilityFall)(ReturnFall)
0.07 = (ProbabilityRise)(.1375) + (1 - ProbabilityRise)( –.0625)
ProbabilityRise= 0.6625
ProbabilityFall= 1 – ProbabilityRise
= 1 – 0.6625
ProbabilityFall= 0.3375
Expected payoff at expiration = (0.6625)($1,200,000) + (.0.3375)($0)
Expected payoff at expiration = $795,000.
This happens at one year from now
Present value = PV = ($795,000 / 1.07) PV = $742,990.65