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Dear Sir,
In example 1 delaying the decision to undertake the project they say that after considering option to delay the company can bid 9,6 (value of call option) instead of 5,8 (project’s NPV). Could you please explain why they don’t add value of option to delay to the value of the project?
Thank you.Thank you. Could you please explain what is the difference between this example where value of the project is the value of the option to delay and Digunder Dec 07 where overall Value of the Project is Project NPV plus the value of the delay option?
pending johns reply, i think i understand wat u meant and since we all one acca family i might just help
the first example its a mutually exclusive situation, they must undertake the investment now or delay till the future so they choose one either to invest now or in 2 years time and since in 2 years time option valuation gives the higher npv thats what theyll obviously choose.
the second and third examples are not mutually exclusive. the company can enjoy both npvs.
they can undertake investment and get that option to sell it at the end of its usefull life or they can undertake investment and pursue a follow on project also simultaneously in 2 years. so theyll enjoy both npvs so for that reason we add.I hope this answers your question.
Thank you but actually I tried to compare example 1 from article dealing with option to delay to exam question Digunder from December 2007 also dealing with option to delay a Project. In the answer in my BPp book they say that the overall value of the Project is its NPV plus the option to delay.
The examiners answer to Digunder was wrong, and BPP have not changed the answer in their Revision Kit. (Kaplan have changed their answer).
The value of the option is the difference between the NPV using the Black Scholes formula, and the original NPV with no option.
(My lecture on real options is wrong in this respect – I was following the original exams answer but I will re-record it because of the above point.)
Dear Sir,
Sorry for coming back this old topic! I also have same question, but now is the case in Q4 June 2011. In the answer, overall NPV = option value (BSOP) + NPV without option to delay. But in the example 1 of ACCA technical article “Investment appraisal and real options”, the option value is compared with the NPV without option! I am confused between these 2 answers.
There has been confusion because the examiner in June 2011 originally got the answer wrong, and my lecture is wrong as a result (and, I think, the BPP Revision KIt answer is wrong (because it is a copy of the examiners original answer).
The value using the Black Scholes model is the NPV including the option.
If you subtract from this the NPV without the option,then the remainder is the value of the option itself.
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