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    • Avatar of John Moffat says

      No – the $4m given in the question is the NET present value.
      Since the cost is $24M, it therefore means that the PV of the returns is $28M

      (PS If you want me to answer a question then please post it in the Ask the Tutor F5 Forum – it is not possible for me always to read all the comments under lectures :-) )

  1. avatar says

    Hi John, I’m sorry but the question below confused me, could you please clear it out? thanks much appreciated :)

    June 2012 Q1 part iii)

    In the Model Answers the examiner answers it in the following way:
    Price of asset (PV of future positive cash flows) = $2,434,000
    Exercise price (initial cost of project, not discounted) = $2,500,000
    Time to expiry of option = 2 years
    Risk free rate (estimate) = 3·2%
    Volatility = 42%
    d1 = [ln(2,434/2,500) + (0·032 + 0·5 x 0·422) x 2]/(0·42 x 21/2) = 0·359 (in normal distribution tables is = .1368)
    d2 = 0·359 – (0·42 x 21/2) = –0·235 (in normal distribution tables is = .0910)

    N(d1) = 0·5 + (0·1368 + 0·9 x (0·1406 – 0·1368)) = 0·6402 ***What is the + 0·9 x (0·1406 – 0·1368 part??
    N(d2) = 0·5 – (0·0910 + 0·5 x (0·0948 – 0·0910)) = 0·4071 **What is the + 0·5 x (0·0948 – 0·0910)) part??

    ***Shouldn’t it just be N(d1)= 0.5 + 0.1368 = 0.6368
    **Shouldn’t it just be N(d2) = 0·5 – 0·0910 = .409
    :/

    • Avatar of John Moffat says

      It is because the tables only have two decimal places when you are looking up. So for 0.359 he has taken 90% of the way between 0.35 and 0.36.
      Similarly, for 0.235 he has taken half way between 0.23 and 0.24.

      I don’t think you would lose any marks for not doing that (and therefore just going to the nearest) even though your final answer would be slightly different.

  2. Avatar of NEENA says

    Sir in this example u have added the value to delay the option to the NPV. BUT there is a question of past paper DIGUNDER of Dec 07. kaplan in its previous answer have added the value of option (i.e 7.48) with projects npv (i.e. 4). When they have amended in new edition they just write as 7.48 which incldes 4m intrinsic value and rest is time value. please resolve my query whether the value of project would taken after addition or the value got from the formula is the eltimate answer?

    • Avatar of John Moffat says

      Without the option, the value of the project is simply the NPV.

      If we do have the option, then the option itself has a value.

      So…..the value of the project together with the option is higher. It is the NPV plus the value of the option.

  3. avatar says

    Dear Sir,
    is one expected to switch between discrete and continuos rates within such tasks (e.g., if the same risk-free rate given for project appraisal is expected to be used also for pricing of a real option)?
    The difference isn’t likely to exceed a couple of bps, so my concern is mostly methodology.
    Thank you very much for support,

      • avatar says

        Thank you very much for your answer. Could you please comment in a little bit more detail on the following:
        when I’m calculating the NPV, the rates given are assumed to be discrete, so the P1=P0(1+R1), etc, but when I calculate the value of a real option, I apply the Black Scholes formula, which in general case assumes continuous compounding . So my question was, in fact, whether I am supposed to convert the risk-free rate to continuous setting before pricing the option, or whether this can be ignored.

        Thank you once again,

    • Avatar of John Moffat says

      We do not have lectures on all topics – more will be added as time permits.
      Mergers and acquisitions are an important area – they are covered in the course notes (and most of the techniques involved are covered in other lectures).

      • Avatar of questforknowledge says

        Hi John, you know some of us rely on these your lectures to understand some of these topics because most are new to us: i know your services are free and on behalf of all those using this site i would like to say thank you: but leaving some topics at this level of the course will mean making things difficult: it will prefereable the topics that were covered in an earlier course be left out than leaving out something new at this level
        thank you

      • Avatar of John Moffat says

        Two things:

        Firstly, we do not pretend to offer a distance learning course. We provide everything on the site voluntarily in our spare time to try and help people. We make it clear that we are not trying to replace study texts.

        Secondly, mergers and acquisitions are best not regarded as a separate topic for learning. As with so much of P4 it draws upon existing knowledge (there is not so much extra to learn at P4 than what has already been learned at F9) but expects more depth. This is not a topic that I actually lecture much on during courses I teach – instead we look at past exam questions and sort it out from there. Again, we make it clear on this website that it is so important to practice questions – at the very least past exam questions, but preferably using an exam/revision kit from one of the approved publishers.

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