ACCA AFM · Guided practice (Show me how)
Chapter 14: Real Options
Real options: valuing the right to wait
Warsaw plc can undertake a project requiring $10 million with an expected NPV of $2 million. It can delay starting for 3 years. Volatility is 20% and the risk-free rate is 6% a year. Work in $m. Report d1 and d2 to two decimals before lookup. Report both terms of the call value to two decimals before subtracting, and carry that reported call into the value-added calculation.
The table extract gives the area between zero and the stated positive d.
| d | Table area |
|---|---|
| 0.86 | 0.3051 |
| 0.87 | 0.3078 |
| 0.88 | 0.3106 |
| 1.21 | 0.3869 |
| 1.22 | 0.3888 |
| 1.23 | 0.3907 |
The five inputs
Calculate the underlying present value and the BSOP d1 and d2 values.
Value the option and what it adds
Calculate the normal probabilities, the option value and the value added over immediate investment.
Opening this exercise…