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28 Sep 2019
You can invest in a risk-free investment technology thatrequires an upfront payment of 1.07 million and will provide aperpetual annual cash flow of 118,000. Suppose all interest rateswill be either 10.1% or 4.9% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4.9%to 92%. The one-year risk-free interest rate is 8.2% and today'srate on a risk-free perpetual bond is 5.1%. The rate on anequivalent bond that is repayable at any time (the callable annuityrate) is 9.1%.
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 investment technology thatrequires an upfront payment of 1.07 million and will provide aperpetual annual cash flow of 118,000. Suppose all interest rateswill be either 10.1% or 4.9% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4.9%to 92%. The one-year risk-free interest rate is 8.2% and today'srate on a risk-free perpetual bond is 5.1%. The rate on anequivalent bond that is repayable at any time (the callable annuityrate) is 9.1%.
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.
Keith LeannonLv2
28 Sep 2019
