You’re planning to outsource 60% of your manufacturing function to a lower cost location sometime in the next six months. Suppose the value of the…

1.You’re planning to outsource 60% of your manufacturing function to a lower cost location sometime in the next six months. Suppose the value of the plant today is £100m. Your plan is to economise 60% from outsourcing. Risk uncertainty in the operating environment is estimated by an annualized standard deviation of 50% in cash flows. The risk-free rate of return is 8% per annum. Use the binomial option pricing approach with a time step of three months to value the option to outsource operations. Is there an optimal time for taking such an action?
2.You’re planning to expand the operations of your manufacturing plant by 50% sometime in the next six months. Suppose the value of the plant today is £100m. The cost from expansion is £40m. Risk uncertainty in the operating environment is estimated by an annualized variance of 25% in cash flows. The risk-free rate of return is 3% per half annum. Use the binomial option pricing approach with a time step of three months to value the option to expand operations. Is there an optimal time for taking such an action?







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