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purplebat285Lv1
28 Sep 2019
You can invest in a risk-free technology that requires anupfront payment of 1,180,000 and will provide a perpetual annualcash flow of 114,000. Suppose all interest rates will be either9.9% or 4.7% in one year and remain there forever. The risk-neutralprobability that interest rates will drop to 4.7% is 89%. Theone-year risk-free interest rate is 8.2% anid today's rate on arisk-free perpetual bond is 5.1%, the rate on an equivalent bondthat is repayable at any time(the callable annuity rate is8.5%.
a. What is the NPV of investing today?
b. What is the NPV of waiting and investing tomorrow?
c. Verify that the hurdle rate rule of thumb gives the correcttime to invest in this case.
You can invest in a risk-free technology that requires anupfront payment of 1,180,000 and will provide a perpetual annualcash flow of 114,000. Suppose all interest rates will be either9.9% or 4.7% in one year and remain there forever. The risk-neutralprobability that interest rates will drop to 4.7% is 89%. Theone-year risk-free interest rate is 8.2% anid today's rate on arisk-free perpetual bond is 5.1%, the rate on an equivalent bondthat is repayable at any time(the callable annuity rate is8.5%.
a. What is the NPV of investing today?
b. What is the NPV of waiting and investing tomorrow?
c. Verify that the hurdle rate rule of thumb gives the correcttime to invest in this case.
Elin HesselLv2
28 Sep 2019
