EVALUATION OF THE FIRM AND ACTUAL OPTIONS
Newly hired, your boss will entrust you the analysis of the following project. A project Whose value without option is $ $200 at t = 0 and this value can increase by a factor u = 1.25 or Decrease by a factor d = 0.8. The project has an option exercisable at any time (at each node) providing a 30% increase in the value of the project, but requires $70 (funds), and a Contraction Option exercisable at any time providing additional $ 50 accompanied by a 20% reduction in the value of the project.
Both options (expansion and contraction) are present at the same time in the project. The tree Binomial has three periods of one year (so four dates: 0, 1, 2, 3) and the risk-free interest rate is 5% (continuous rate).
A) What is the value of the project at t = 0 by including ONLY the value of the option Expansion? Use the binomial model to determine the value of the expansion option.
B) What is the value of the project at t = 0 by including ONLY the value of the option contraction? Use the binomial model to determine the value of the contraction option.
C) What is the value of the project at t = 0 by including the value of the TWO options combined? Use the binomial model to determine the value of the combined options.