00:01
Once again, welcome to new problem.
00:05
This time we're dealing with capital.
00:08
So when you think about capital, you're always thinking about the investments needed to produce revenues for businesses.
00:28
So these are investments needed to produce revenues for businesses.
00:35
In that process, we have something called the cost of capital.
00:42
And the cost of capital is representative of the return.
00:49
A company needs to return a company needs to achieve.
00:58
Achieve in order to justify the cost of a capital of a capital project.
01:15
And your typical capital project would be things like new equipment or building construction.
01:29
So we have new equipment and we also have building construction and these ones are the costs of capital.
01:39
So we have a new problem and in this particular problem you're looking at probabilities and these probabilities are risk neutral probabilities.
01:54
Probabilities.
01:57
These are risk -neutral probabilities.
02:02
And the meaning of this is that the cost of capital, the cost of capital, is at the risk -free rate and when you think about these risk -free rate, you have different kinds of rates.
02:41
So current interest rate for risk -free opportunity is 8%.
02:58
So it's 8%.
03:00
And this is one year.
03:03
Well, actually not this is one year.
03:07
So we're going to say in one year, it so happens that there's a 60 % chance that all risk -free interest rates.
03:31
Will be 9 .5 % and stay there forever.
03:40
So they're going to stay there forever.
03:43
And then we also have the fact that these 35 % chance that there'll be 5 .5 % and and stay there forever so 5 .5 % and stay there forever and then also 35 % chance that they will stay there forever so that's what you're seeing there the current current risk free rate the current risk free rate is 7 % and in this sense, we want to determine the cost of capital.
04:35
So you want to determine the cost of capital.
04:40
So we're going to have the points.
04:43
We have different points that we're dealing with in the problem.
04:47
So we had 60 % paired up with 9 .5%.
04:50
We also had 35 % paired up with 5 .5%.
04:54
And we had another 35%.
04:56
We should have included this one 35 % chance that there'll be 5 .5 % and stay there...