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Hi John,
Thank you very much for your detailed explanation. Everything suddenly makes sense 🙂
Hi John,
Thank you very much for your clarification.
I’m trying to figure out a correct answer to this question: it seems that the option in question is: if project value in the future exceeds $35m, then exercise the option and go for the additional investment of $35m, if project value falls below $35m, and do not invest further. It seems that the two $7m initial investments were not considered in the option at all, and they would have been incurred no matter what.
So can we consider the $7m investments separately to the $35m further investment and future cash inflows?
If we completely ignore the two $7m investments:
The option value is still unchanged at $9.127m, however, the NPV of the project is -$28.42+$18.28+$11.86+$5.93+$2.68=$10.33m. It looks like the project value with option is lower than the project value without option to delay-this gives a negative value added by the option of delay, but in theory an option couldn’t lower value of a project…
I’m confused by the calculation results… Could you please help to see what’s wrong here? Thank you very much!