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NPV with option = 1.36
NPV without option = -1.01Shouldn’t overall value be = 1.36-(-1.01) = 2.37
But what examiner did was = 1.36 – 1.01 = 0.35
Can you give me an explanation for this??? (Question Furlion Co – Mar/Jun 16)
What the examiner has done is correct.
The overall value with the call option is the value without the option (which is -1.01) plus the value of the option (1.36).
-1.01 + 1.36 = 0.35
(The value with the option is more than it would be if the option did not exist)
But sir in your lecture you have shown ,
Value of the option = (NPV with option available to us – NPV without option available to us)
this difference is value of the option but here you are adding instead of deducting. Can you explain me why???
But examiner calculated overall value, So does this overall value indicate value of the option???
Rearrange the equation you have written down from the lecture, and you get:
NPV with the option = NPV without the option + value of the option.
This is what the examiner has written in his answer. The overall value with the option is equal to the value without the option plus the value of the option!
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hello
I believe that Simon is correct. There is something wrong with descriptions in the notes for the lectures.
Example for real options states, that c is value of NPV with option. And to get to value of the option, we should subtract from NPV with option the NPV without it.
3.92 (c) – 2 (NPV) = 1.92 – description states that this is value added to the option.
This doesn’t tie to equations provided above.
Regards
PJNo – the notes and lectures are correct! 🙂
The example in the notes is an option to delay, and for an option to delay the value given by the formula is the value of the project including the option.
(If you look at the formula, it is essentially Pa – Pe (the other ‘bits’ are all dealing with the uncertainty and the timing) which if it were not for the uncertainty and the timing would be the NPV of the project).The question Furlion is an option to expand and for this the formula does give the value just of the option and this is in addition to the value without the option.
(The example I use in the lecture is in fact a past exam question. It was set by the previous examiner and his answer was wrong (he did add the value of the option to the NPV of the project). The current examiner has clarified that the answer was wrong and that the answer in my notes and lectures is correct 🙂 )
It is only if it is an option to delay that the rule is as per my notes/lectures. For other options, the figure from the formula is just the extra value relating to the option itself.
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Thank you for clarification! Do you think that it would be possible to add this last two sentences from your comment to Notes? I think it would help few students.
Regards
PJ
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