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Sir John,
Could you please advise me in regard to BSOP model?
When looking at excercise MMC, while valuing real options and calculating the Pa we only take the positive CF after the excercise options – we do not include the additional -35 milion.
When looking at excercise Furlion we see that CF of 15 milion is taken in Pa as discounted value and Pe as not discounted.
This is the only matter that is a little bit unclear to me. I’ll be thankful if you could explain.
In MMC, 35M is the exercise price and is therefore Pe. Pa is the PV of the flows that occur afterwards if the option is exercised.
In Furlion, we are told that the NPV is zero and given that the expenditure is 15M it must mean that the PV of the flows afterwards must also be 15M.
Dear Sir,
thank you for the answer. I just can’t put my head around it, since it says in BPP Study Book – Pa is the PV of CF generated after the exercise of the option… so if cost of exercise is 60 Mio and NPV after is said to be 10 Mio then we discount 70 Mio. If you could try and explain it in different wording that would be great, for me it seems the same like in MMC scenario, instead here we add the cost to Pa and we do not do it in MMC.
In all cases the NPV is the PV of future flows less the initial investment.
So if we are given the PV of the future flows then this is Pa.
However if we are given the NPV then the PV of the future flows (using the first line of this reply) must be equal to the NPV plus the initial investment.
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