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AFM March/June 2019 2bii) Asset Price of Jigu Project

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  • This topic has 1 reply, 2 voices, and was last updated 1 year ago by John Moffat.
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  • October 23, 2020 at 11:28 am #592920
    catrinhaf93
    • Topics: 2
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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!

    October 23, 2020 at 1:37 pm #592941
    John Moffat
    Keymaster
    • Topics: 57
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    • ☆☆☆☆☆

    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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