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Hi John,
Just a bit confused about how they worked out the Current Price of the project by taking the exercise price and multiplying it by the cost of capital to the power of 3. 15*1/1.12 to the power of 3= 10.68
I don’t understand the logic behind it.
The 15M is payable in three years time, and so it has been discounted for 3 years.
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And this is the case only because its a option to expand? for instance Digunder(12/07) which was an option to delay smply added together the exercise price of 24 and the NPV of 4.
why are two different methods used?
Thanks in advance.
Yes – it is because it is the option to expand. So in Furlion the basic project would start now regardless.
Whereas with Digunder it would not start until the buy the land.Hi John,
Could I understand that 03 years time means $15mil shall be invested in the next 03 years (which is 0,1,2 -> year 2) then investment should be discount at 1/1.12^2 rather than 1/1.12^3?
Thank youNo.
0, 1, 2 etc are points in time (not whole years).
Time 0 is now (the start of the first year)
Time 1 is one year from now (the end of the first year / start of the second year)
Time 2 is two years from now (the end of the second year / start of the third year)So if a flow is in 3 years time, then it is 3 years from now (time 3) and needs discounting for 3 years.
Hi John, the question mentions that $15 million is an additional expenditure in 3 years time if the Naswan Govt is able to obtain funding to expand, I did not understand why it is used to calculate Pa as it seemed more like an additional capital injection in year 3. Would that not be the Pe instead since there is no mention of capital injection in Year 0.
Alsoo, there is mention of the negative NPV of $1.01 million and expected NPV for the expansion being $0. Would these information not to be used to calculate the Pa and Pe?
If the NPV for the expansion is $0, then the PV of the inflows less the outlow of $15M must be zero. Therefore the PV of the inflows must be $15m.
It makes sense to $15m as PV of cash inflow, which, if net against PV of initial outlay of $15m, it produces $0 NPV. So, if $15m is already in present value, why is it still been further discounted at cost of capital?
The expansion doesn’t take place until three years time so expected NPV is 0 in three years time.
In that case, wouldn’t the $15m of capital expenditure (Pe) will need to discount by 3 years as well since the $15m additional investment is at three years time as well?
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