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Dear Sir,
I am at a loss as to why the price of the underlying asset (Pa-in the Black Scholes Option Model) has been discounted twice, by the examiner.
Since the NPV of the expansion is zero, I thought the Pa would be $15.
The current price (Pa), as I have read, is the value post the exercise period. It would seem that the present value post exercise is $15. But why has this been discounted again?
Please help.
Kind regards
The NPV of $0 is the estimated NPV as and when the project is started (i.e. in 3 years time).
So the PV of the receipts is $15 in 3 years time and needs discounting for 3 years to get the PV now.Right, Sir.
Thank you for your help. It is beginning to make sense now.Will this always be the situation with an option to expand?
How is this different from an option to delay? I have not come across a similar treatment for an option to delay. Take the case for Digunder in Dec 2007 (option to delay), for example.
I cannot seem to reconcile the two for consistency.
Kind regards
I am scared to say it will always be the situation – it depends on the wording of the question – but it is likely to always be the case.
The difference in Digunder is because it is an option to delay and therefore the NPV has been calculated ignoring the option.
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