A.

Project Delta
Year Cash Flow PV
1 150 130.43
2 200 151.23

If Linear Dynamics has similar risk profile as Project Delta, It could use a rate

B. Risk free return 10%

0
Set up cost 1,500,000
Outgoing Cost
PV
Total PV of Cost 1,982,042

0.6 High Growth State

PV
Total PV
0.4 Low Growth state
PV
Total PV

Value of production 5,939,143.66

C. If the investment is delayed by 1 year,

Value of delayed Production today 5,164,472.75

Value of the option to delay 774,670.91

 Rate
15%
15%

Delta, It could use a rate of return of 15% for their investment

Expected return 15%

1 2 Terminal Rev

250,000 350,000
217,391 264,650

1,100,000 1,250,000 8,330,991.31

956,522 945,180 5,477,762
7,379,463 272.32%
800,000 600,000 3,998,875.83
695,652 453,686 2,629,326
3,778,664 90.65%
 Extraction and sale Tonnes

Today 10000
One year from now 15000
10000
2 years from now 15000

A.
Risk free rate 5%
Portfolio Return t=0 t=1 PV
15 17.25 16.43
12.75 12.14

So, Risk neutral probability => 15 = w*16.43 + (1-w)*12.14

On solving, w 0.67

t=0 t=1 PV Prob

15 17.25 16.43 0.67
12.75 12.14 0.33

So, risk neutral probability of a good state realization is 67%

B. Valuation of Coal Mine

0.67 In Good State

0 1 2
Tonnes 10000 15000 15000
Cost per ton 50 62.5 78.125
Cost $ 500,000 $ 937,500 $ 1,171,875

Price/ton 150 165 175

Revenue $ 1,500,000 $ 2,475,000 $ 2,625,000

Profits $ 1,000,000 $ 1,537,500 $ 1,453,125

PV $ 1,000,000 $ 1,464,286 $ 1,318,027
NPV $ 5,369,615

So, probability adjusted value of the mine $ 5,470,447.85

 Today
good state 1-yr from now
Bad state 2-yrs form now

0.33 In Bad State

Unextracted coal 0 1
10000 Tonnes 10000 10000
Cost per ton 50 62.5
Cost $ 500,000 $ 625,000
Residual Value
Price/ton 150 165
$ 1,750,000 Revenue $ 1,500,000 $ 1,650,000

Profits $ 1,000,000 $ 1,025,000

$ 1,587,302 PV $ 1,000,000 $ 976,190
NPV $ 5,675,170
Price Cost
150 50
165 62.5
175 78.125

2 Unextracted coal
15000 15000
78.125
$ 1,171,875
Residual Value
175
$ 2,625,000 $ 2,625,000

$ 1,453,125
$ 1,318,027 $ 2,380,952