In the March/June 16 exam Q4 is similar but they had discounted the pv of cash flows (Pa). The Pe was 15 and the NPV was 0. Pa was 10.68 (15 x 0.712) which is not the case for this question. Why is that so? As both are delay options.

In the March/June questions, they have not discount the PV of the cash flows (it would be silly to discount a present value). What they have done is calculated the PV of the cash flow (the flow being $15 in 3 years time).

The same applies to the lecture example (which is also a past exam question), but the reason we don’t need to discount is because it is already discounted – given that the outlay is $10M now, and the NPV is 0, then the PV of the flows has to also be $10M. Since this is already a present value, it is already discounted.

In Kaplan Book, it states,”all options to delay/defer, option to switch/redeploy and option to expand/follow-on are call option. But in opentuition, notes option to switch/redeploy is considered as put option,, so i am confused,,, is Option to switch/redeploy call or put option?,, i want to confirm this with you. &

In case of option to abandon,,, how is Pa and Pe and t is computed?

Hi is it liekly we could be asked to work out the value of a put option? and if it could be tested would we just find the put option using the black scholes model and then just deduct the NPV Thanks

Mr John, In my understanding value of option is what we pay for the option. But from this example it appears c is the total value including option price.

I am also bit confused. Because in the share pricing lecture we state that Pa is the current market value – which I would see as the current investment, the 10mio. Pe is the expected value of the project – for me this is what I get at the end, so 12 mio. Could you please clarify a bit here?

However, I’m still confused with examiner’s answer re: Q4 June 2011 MMC, option to delay. The call option=$9.53m=full value of project with option to delay. because NPV is negative -2.98m =value of the project without option is -2.98m, so the value added by option should be 9.53-(-2.98)=12.51.

I don’t understand the examiner’s answer below: Overall value of the project = $9·53m – $2·98m = $6·55m. I thought overall value is $9.53m??

I get confused with the full value of project. The value of the call option to delay is 3.92m, does it mean the company has to pay 3.92m to buy this option to delay the project? id it is the case, then NPV=2m, the full value of the project will be 2-3.92=-1.92. the company made a loss?

Thanks. by looking at the answer in notes, I realise that 3.92m is full value of the project with the option, so without option is NPV 2m, the value of option is 1.92m which is different from the lecture. Is it right?

The difference is that the option in the lecture notes is an option to delay the existing project, but the March/June question was the option to expand – effectively to do the project as it is but to have the option to invest more and get more (almost like the option to do an extra project).

I’m a bit confused, in the lecture and comments below you have explained that 3,92 makes the value of the whole project greater than it would have been without the option to delay and the full value of the project is 5.92. However in this comment and in lecture notes the full value is 3,92.

In the example we take Pa as 12m as the value of the project. Shouldn’t we be taking Pa as 2m ie the NPV as that can also be denoted as the value of the project?

Just to get clarification on this. From the start of your lecture you mentioned that value of the project = NPV, which concurs with Arun’s question. I am now confused with your answer to his question. Would you kindly clarify as i am kind like getting two conflicting sets of information thanks

I am also bit confused. Because in the share pricing lecture we state that Pa is the current market value – which I would see as the current investment, the 10mio. Pe is the expected value of the project – for me this is what I get at the end, so 12 mio. Could you please clarify a bit here?

I don’t really understand why that makes it less confusing. You must have a scientific calculator in the exam and it should have a button for e^x, and using that button is a bit faster than typing out e to 5 decimal places 🙂

Maybe i did not understand his problem but from the way i understood it i think it has to do with him using his scientific calculator cause nothing can be confusing about that e .

Hi, I find the most confusing part to define Pa and Pe. in this case maybe these variables are more straightforward, but in other cases like adandon, redeploy or expand they are less clear. Could you please provide guidelines how to define these variables.

Because you have the option to invest at a fixed cost on a future date (just like a call option for shares gives you the right to buy at a fixed price on a future date).

gayathriharidas says

Dear sir,

In the March/June 16 exam Q4 is similar but they had discounted the pv of cash flows (Pa). The Pe was 15 and the NPV was 0. Pa was 10.68 (15 x 0.712) which is not the case for this question. Why is that so? As both are delay options.

Thank you in advance 🙂

John Moffat says

In the March/June questions, they have not discount the PV of the cash flows (it would be silly to discount a present value). What they have done is calculated the PV of the cash flow (the flow being $15 in 3 years time).

The same applies to the lecture example (which is also a past exam question), but the reason we don’t need to discount is because it is already discounted – given that the outlay is $10M now, and the NPV is 0, then the PV of the flows has to also be $10M. Since this is already a present value, it is already discounted.

gayathriharidas says

Thank you for the clarification Sir.

So when using the option pricing formulas :

Pe : Actual expense / cost of abandonment (not Pv)

Pa : Pv of cashflow

John Moffat says

correct 🙂

ashiktamot says

Dear John,

In Kaplan Book, it states,”all options to delay/defer, option to switch/redeploy and option to expand/follow-on are call option.

But in opentuition, notes option to switch/redeploy is considered as put option,, so i am confused,,, is Option to switch/redeploy call or put option?,, i want to confirm this with you. &

In case of option to abandon,,,

how is Pa and Pe and t is computed?

kkhatani says

Hi is it liekly we could be asked to work out the value of a put option? and if it could be tested would we just find the put option using the black scholes model and then just deduct the NPV Thanks

John Moffat says

It is possible (and when it has been asked, the examiner has given a formula for it).

Lilit says

Mr John, In my understanding value of option is what we pay for the option. But from this example it appears c is the total value including option price.

Please could you clarify.

John Moffat says

The lecture needs re-recording. The value added by the option is 3.92 – 2 = 1.92M

(see the printed answer in the lecture notes).

annchen says

Hi John,

I am also bit confused. Because in the share pricing lecture we state that Pa is the current market value – which I would see as the current investment, the 10mio. Pe is the expected value of the project – for me this is what I get at the end, so 12 mio. Could you please clarify a bit here?

Thanks!

Ana

helensqq says

Thanks John,

However, I’m still confused with examiner’s answer re: Q4 June 2011 MMC, option to delay. The call option=$9.53m=full value of project with option to delay. because NPV is negative -2.98m =value of the project without option is -2.98m, so the value added by option should be 9.53-(-2.98)=12.51.

I don’t understand the examiner’s answer below:

Overall value of the project = $9·53m – $2·98m = $6·55m.

I thought overall value is $9.53m??

John Moffat says

The examiners answer was wrong (and he has since accepted this).

What you have written is correct 🙂

helensqq says

hi John,

I get confused with the full value of project. The value of the call option to delay is 3.92m, does it mean the company has to pay 3.92m to buy this option to delay the project? id it is the case, then NPV=2m, the full value of the project will be 2-3.92=-1.92. the company made a loss?

Thanks.

John Moffat says

It is not that they are paying for the option.

If the option exists then the project is more beneficial than if it does not exist.

helensqq says

Thanks. by looking at the answer in notes, I realise that 3.92m is full value of the project with the option, so without option is NPV 2m, the value of option is 1.92m which is different from the lecture. Is it right?

John Moffat says

That is correct

cyh says

Hi Sir,

i refer to the March/June 2016 SAMPLE Question 4, real option.

The NPV of the project is -1.01M, the call option is 1.36M, so the overall value is 1.36-1.01=0.35.

This is different from what u reply on 28 November 2016, so i am confused now.

John Moffat says

The difference is that the option in the lecture notes is an option to delay the existing project, but the March/June question was the option to expand – effectively to do the project as it is but to have the option to invest more and get more (almost like the option to do an extra project).

cyh says

so for the delay/abandon option, total value of project would be the value of the option

for the expand option, the total value of project would be the value of the option + original NPV.

am i correct?

John Moffat says

That is correct 🙂

susannnnnnnnnnn says

Hello, I just read the article (https://www.accaglobal.com/gb/en/student/exam-support-resources/professional-exams-study-resources/p4/technical-articles/investment-appraisal.html), the example of abandon option, NPV is negative 0.45m, put option 3.45m, then it says “Net present value of the project with the put option is approximately $3m ($3.45m – $0.45m)”. it seems the total value of the project with abandon option is the put option plus original NPV?

cyh says

c=3.92m. how do we interpret this amount ? NPV is 2M, so the total NPV + delay option is 2+3.92= 5.92M?

or total NPV + delay option is 3.92m, and the delay option is worth 3.92-2=1.92M?

John Moffat says

The second line.

cyh says

how about the put option? if p = $3m, NPV is 2m, so the abandon option is worth 3-2m=1m?

John Moffat says

Correct.

ljax says

I’m a bit confused, in the lecture and comments below you have explained that 3,92 makes the value of the whole project greater than it would have been without the option to delay and the full value of the project is 5.92. However in this comment and in lecture notes the full value is 3,92.

Can you please explain it in more details.

Thanks a lot!

John Moffat says

The comment above and the answer in the lecture notes are correct, and I must re-record the lecture – thank you for reminding me.

My excuse is that I did in the lecture what the examiner did in his answer the first time calculations on real options were asked.

More recently the examiner realised he was wrong! I will re-record the lecture. (All the other figures will obviously remain unchanged)

ljax says

Thank you so much!

John Moffat says

You are welcome 🙂

Arun says

Hi John,

In the example we take Pa as 12m as the value of the project. Shouldn’t we be taking Pa as 2m ie the NPV as that can also be denoted as the value of the project?

Thanks.

John Moffat says

The value of the project is the PV of the future flows – not the NPV. The NPV is the value of the returns less the investment.

bluestone49 says

Just to get clarification on this. From the start of your lecture you mentioned that value of the project = NPV, which concurs with Arun’s question. I am now confused with your answer to his question. Would you kindly clarify as i am kind like getting two conflicting sets of information thanks

annchen says

Hi John,

I am also bit confused. Because in the share pricing lecture we state that Pa is the current market value – which I would see as the current investment, the 10mio. Pe is the expected value of the project – for me this is what I get at the end, so 12 mio. Could you please clarify a bit here?

Thanks!

Ana

zee says

Dear Sir,

I’m struggling to perform the calculation on the last part of the call option formula, that is with the “e”. Can you please clarify one by one.

John Moffat says

Have you watched the lectures on normal option pricing, because I go through the steps slowly in that lecture?

tich2010 says

Instead of using e use 2.71828 that will make the calculation not confusing.

John Moffat says

I don’t really understand why that makes it less confusing. You must have a scientific calculator in the exam and it should have a button for e^x, and using that button is a bit faster than typing out e to 5 decimal places 🙂

tich2010 says

Maybe i did not understand his problem but from the way i understood it i think it has to do with him using his scientific calculator cause nothing can be confusing about that e .

Rst says

Hi,

I find the most confusing part to define Pa and Pe. in this case maybe these variables are more straightforward, but in other cases like adandon, redeploy or expand they are less clear. Could you please provide guidelines how to define these variables.

lonyovko says

d2 was .8727, why did we round to .88 and not .87 when looking for N(d2)?

John Moffat says

My mistake – I should have used 0.87 (or even better apportioned between 0.87 and 0.88, but there is no real need to do that).

sogan0 says

Hi Lecture how do you arrive to 0,.3888 I understand how to get to 1,2 in the table but not how to get to 0.3888

John Moffat says

You look to the row for 1.2 and the column for 0.02

I don’t know if you have watched the previous lectures on share options, but I spend time in that lecture showing how to use the tables.

badmus4u says

Why and how is the option in the example a call option? I did not really get the justification.

Thanks

John Moffat says

Because you have the option to invest at a fixed cost on a future date (just like a call option for shares gives you the right to buy at a fixed price on a future date).

badmus4u says

Oh I get. Thanks a lot.

sogan0 says

Thank You

Fabregas says

Sir,

Can you please add an option to adjust the speed of the video? Although it is very informative, I find it hard to concentrate at a low pace.

Thank you