Nente Co (June 2012)

$603,586 is the value of the investment with an option to delay, whereas $405,000 is the value of the investment without the option to delay. (So the benefit of having the option is the difference between the two).

To help explain:

Without the option, the NPV is $2,434,000 less the PV of $2,500,000.

With the option, if you look at the Black Scholes equation, it is still basically Pa (2,434,000) less the PV of Pe (2,500,000). As I explain in my lectures on this multiplying Pe by the term with ‘e’ in it is actually doing the discounting of Pe on a continuous basis (i.e. day by day instead of yearly). The other terms in the equation are dealing with the uncertainty etc..

No, not in this case (for the reasons I explained).

The previous examiner though the same as you, but the current examiner has accepted that the answer to the question set by the previous examiner was wrong.

Nente was set by the current examiner, and his answer is correct 🙂

There is a difference in that Nente is an option to delay the whole project, whereas Mesmer is an option to abandon (to delay the decision as to whether or not to continue).

Both answers were written by the current examiner and are both correct.

I appreciate it is confusing, but fortunately the examiner also appreciates this and the majority of the marks are always for being able to use the Black Scholes formula and not for the final answer.