Black-Scholes option pricing model

This topic has 3 replies, 3 voices, and was last updated 5 months ago by John Moffat.

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January 26, 2022 at 8:39 pm #647546
shaunak22
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SCENARIO –
Project 1 has an NPV of –$10,000; it will also develop expertise so that Entraq would be ready to
penetrate the European market with an improved product in four years’ time. The expected cost at Time 4 of the investment is $600,000. Currently the European project is valued at 0 NPV but management believe that economicconditions in four years’ time may change and the NPV could be positive. The standard deviation is 30%, the risk-free rate is 4% and the cost of capital is 10%

QUESTION – list down the vairiable needed to complete call option formula

Pa = PV of cash inflow
Pe = cost of investment

ANSWER

Pa =600000 discounted back to time 0 @10% =409800
Pe =600000

DOUBT

1) should’t the present value of cash inflow be 590000 since they invested 6000000 and got a negative NPV -10000 ?

2) the present value of cash inflow is not mentioned how do they know that the present value of cash inflow is 600000
January 27, 2022 at 9:14 am #647577
John Moffat
Keymaster
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1. The question says that the NPV of the European project is zero.

2. If the NPV is zero then the PV of the inflows must be equal to the PV of the outflows.
January 29, 2022 at 2:45 pm #647692
aishathwasma
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Hello, I have watched the lecture on this topic and the example we are getting d1= 1.22 and d2=0.87.
For calculating N(d1) which is N(1.22) we are selecting the probability of 0.3888 which is 0.02 from above the normal distribution table and for N(d2) which is N(0.87) we are selecting the probability of 0.3078 which is 0.07 from the values above the table.

can u explain to me if the values on the top of the normal distribution are taken into account when selecting the probability of N(dx).
January 29, 2022 at 4:55 pm #647708
John Moffat
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But I do explain how to use the tables in the lecture!!

To look up 1.22 we use the 1.2 row, and then for the second decimal place we use the columns. so for 1.22 we use the q.2 row and then the 0.02 column.

For 0.87, we use the 0.8 row and the 0.07 column.
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