Chapter 14, example 1 – why Pa (current "share price") is $12mln?

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April 25, 2013 at 8:17 am #123456
nickxopt
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In P4 June13 Opentuition book in chapter 14 (real options) there is a single example – where you have to estimate the value of the option using Black Sholes model.
To use the call option value formula you have to identify Pa and Pe from the given task.
In answers they say, that Pa is equal to current investment (10mln) + expected NPV (2mln), while Pe = initial investment (10mln).
Why in this case Pa = investment + NPV? Shouldn’t NPV be an opportunity revenue that we loose here if we don’t invest or something else? In given answer it looks like the current cost of the project is the investment PLUS discounted cashflow in, which is very strange.
Opinions?
May 22, 2013 at 11:36 am #126673
nickxopt
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nobody knows at all??
May 26, 2013 at 6:50 pm #127251
rmracca
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Pa for a project is the PV of cash inflow
To calculate NPV of project :
NPV = (PV of Outflow )+PV of cash Inflow
Therefore PV of inflow = NPV + Outflow
So in your query if NPV = +2 and investment =10
Pa ( PV of cash inflow ) = 2 +10 =12
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