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Hi,
I am really struggling to get to grips with real options, and I am confused with the solution to the asset price of the Jigu Project. The cost of the project and the npv have been added together and discounted. I don’t understand why the cost is added to the npv (as it’s a cost so why do we add it on?) and why we discount the npv down again as it’s already been discounted?
Thanks!
Pa is the PV of the future flows from the project.
The NPV at the start of the project (so in 4 years time) is $10,000,000. This the PV of the future flows less the initial cost of $60,000,000. So the PV of the future flows must be $70,000,000.
(The NPV is 70 – 60 = $10M)However this is the PV in 4 years time, but we need to PV ‘now’. So we discount the $70M for 4 years.
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