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ACCA P4 Question 1 December 2013 part 3
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Hi,
i watched this video but i am confused with the last part. Without the option if the project is carried out, NPV will be -$451,000 for the 5 years. If project sold at end of second year, the project is worth $3,444,000. Can you explain why NPV of the project with put option is the addition of both the values above? The NPV of -$451,000 includes the cashflows of the last three years.
Thanks in advance.
Thank you so much , this really means alot ,it helped me out on the bits of confusion I had while attempting the question before watching this.
Hello John
I have a question regarding the calculation of d1.
These are my results
ln(30614/28000) = 0.089
[0.04 + (0.5*s^2)] = 0.101
0.35*2^(1/2) = 0.494
Thus d1 = [(0.089 + 0.101)*2]/0.494 = 0.769
The answer according to this lecture as well as several other sources = 0.589
Can you tell me where I’m going wrong?
Your last line should read:
(0.089 + (0.101*2)) / 0.494 = 0.589
Got it. Thank you ?
You are welcome 🙂
Hi Mr. Moffat,
The question says “Recently Bulud Co offered Chmura Co the option to sell the entire project to Bulud Co for $28 million at the start of year three. Chmura Co will make the decision of whether or not to sell the project at the end of year two.”
Why do not need to calculate the PV of $28 million when doing b(ii)?
Thank you very much. It’s a great lecture!!
$28M is the exercise price. As I explain in my lectures on option pricing, in the formula what we multiply Pe by is there effectively to do the discounting.
one silly question, i am always confused regarding the value of option, is 3.20m we are suppose to pay to buy the put option?
and is it the same reason why we add it to the negative NPV to find the net value of project?
amazing lecture, thanks a ton for taking such an effort for making things easy and manageable, its really helping me.
It is not that we actually pay for the option, but it is how much extra the option makes the project worth to us.
(And thank you for your comment 🙂 )
Very helpful! Just one silly question. If they didn’t give you the risk adjusted cost of capital and you had to work it out, would you then consider the inflation? I presume in this question we assume the 12% they tell us covers that?
Thank you for your comment 🙂
Thank You So Much. Easily and professionally explained. Looking forward to passing
great lecture…many thanks!
Thank you for the comment.
Hi Mr Moffet,
in b(ii) while calculating option pricing, how is the time to expiry is 2 years and not 3 years? is “t” not the years the project life is left? or is it life of project that has elapsed?
Thanks in advance.
The question says “Recently Bulud Co offered Chmura Co the option to sell the entire project to Bulud Co for $28 million at the start of year three. Chmura Co will make the decision of whether or not to sell the project at the end of year two.”
The start of year 3 and the end of year 2, is 2 years from now 🙂
Wow! thank you, lecture made the exam a walk in the park. I think on Friday i will show this exam the level of professionalism you use to tackle the questions. wow.
Thank you for the comment, and good luck on Friday.
You make it all so easy. However, I dont understand why we have to add back the capital allowances to the after tax cash flows.
Thanks, you really made it easy to understand. I understand why we deduct capital allowances before we tax the cash flows but I am not quite clear on why we had to add it back to the post tax cash flows.