High Roller Properties is considering building a new casino at a cost

QUESTION

High Roller Properties is considering building a new casino at a cost of $10 million at t = 0. The after-tax cash flows the casino generates will depend on whether the state imposes a new income tax, and there is a 50-50 chance the tax will pass. If it passes, after-tax cash flows will be $1.875 million per year for the next 5 years. If it doesnt pass, the after-tax cash flows will be $3.75 million per year for the next 5 years. The projects WACC is 11.1%. If the tax is passed, the firm will have the option to abandon the project 1 year from now, in which case the property could be sold to net $6.5 million after tax at t = 1. What is the value (in thousands) of this abandonment option?
After tax cash flow if tax laws are passed Years 0 1 2 3 4 5 WACC 11.10% Cash flows -10 1.875 1.875 1.875 1.875 1.875 PV Factor 0.90 0.81 0.73 0.66 0.59 PV of cash flows -10 1.7 1.5 1.4 1.2 1.1 PV of cash flows= PV factor of $1 * cash flows in that year Sum of PV with taxes= -$3.09 After tax cash flow if tax laws are not passed Years 0 1 2 3 4 5 WACC 11.10% Cash flows -10 3.75 3.75 3.75 3.75 3.75 PV Factor 0.90 0.81 0.73 0.66 0.59 PV of cash flows -10 3.4 3.0 2.7 2.5 2.2 PV of cash flows= PV fcator of $1 * cash flow in that year Sum of PV without¦

= $3.82 Cash flows with and without taxes 0.365 cash flows with and without taxes= cash flows with taxes * probability + cash flows without taxes*probability , [probability=0.5] Value of the abandonment option =Property could be sold for $6.5 m + $1.875 m

ANSWER:

CLICK REQUEST FOR  AN EXPERT SOLUTION