Use Cox-Ross-Rubenstein to construct a 2-year binomial tree for the evolution of cash flows with a binomial period of 1.Assume the initial cash flow (CF₁)is $20 million,σ = 0.45,r = 0.13,g = 0.02,and the project lasts 2 years.What is the value of the project on the up node in year 1?
A) $85 million
B) $185 million
C) $285 million
D) $385 million

Question

Quizplus · Accepted Answer

The up factor (u) is calculated as e^(σ√Δt) = e^(0.45√1) ≈ 1.5683. The cash flow at the up node in year 1 is CF₁ * u = $20 million * 1.5683 ≈ $31.366 million. However, the choices seem to be incorrect based on this calculation, suggesting a possible error in the problem statement or choices.

Use Cox-Ross-Rubenstein to Construct a 2-Year Binomial Tree for the Evolution