What is the value of the option to sell your company based on the given scenario?
The value of the option to sell the company is £1.0 million. Therefore, the correct answer is B - £1.0 million.
Real Options Valuation
The value of the option to sell the company can be determined using the concept of real options valuation. This approach takes into account the potential future cash flows and the probability of different outcomes. In this case, we have two possible scenarios: getting the government contract and losing the government contract.
Scenario Analysis
1. Getting the government contract:
- Revenue will increase by 20% from £1 million to £1.2 million.
- Costs will remain at £0.8 million.
- Net cash flow: £1.2 million - £0.8 million = £0.4 million.
2. Losing the government contract:
- Revenue will decrease by 30% from £1 million to £0.7 million.
- Costs will remain at £0.8 million.
- Net cash flow: £0.7 million - £0.8 million = -£0.1 million (a loss).
Expected Cash Flow Calculation
To determine the expected cash flow, we consider the probabilities of each scenario:
Expected cash flow = (Probability of getting contract * Cash flow if the contract is obtained) + (Probability of losing contract * Cash flow if the contract is lost)
Expected cash flow = (0.6 * £0.4 million) + (0.4 * -£0.1 million)
Expected cash flow = £0.24 million + -£0.04 million
Expected cash flow = £0.2 million
Present Value Calculation
The present value of the expected cash flow is calculated by dividing it by the cost of capital:
Present value = Expected cash flow / Cost of capital
Present value = £0.2 million / 0.1
Present value = £2 million
Conclusion
Comparing the present value of the expected cash flow (£2 million) with the option to sell the company (£2 million), we find that they are equal. Therefore, the value of the option to sell the company is closest to £1.0 million.