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sir this is again a MAJOR MAJOR doubt!!!!!!!!!!!!!
in case of Uwa project, why was negative NPV from Uwa(negative 6m dollars) not added to put option value generated from Honua’s offer(postivitve 2.4m dollars)? that would have yielded us negative 3.6million dollar, meaning that uwa would have been rejected even after Honua’s offer.
and honua’s offer is just for uwa. uwa and jigu have got nothing to do with each other. jigu will still go ahead even if uwa rejected.But the examiner has strangely added jigu’s call option and put option of uwa.
i had asked you this morning –“sir in case of option to abandon, when making the final decision, we will always take the normal NPV(without the option to abandonment) and add to it value of put option? to see the strategic NPV is positive or negative?” and you replied “correct” to it. but here somehow….
You are correct in saying that the two projects are to a large extent separate from each other.
I would have mentioned this in my report (and the examiner makes it very clear, as always, that alternative comments to those that he has made will be given credit).
In a more general sense, do not get in a panic and when you are practicing always look at the marking scheme to see what the marks are being given for.
In this question, part (a) is 5 marks and because it is fairly standard you should be able to get most of the marks.
Part (b)(i) would not have caused much of a problem and is 12 marks.
Part (b)(ii) is again pretty standard arithmetic and you should have been able to get most of the 9 marks.
However it is part (b)(iii) that is what you are worrying about, but if you look at the marking scheme, 8 out of the 10 marks were for discussing assumptions, and although as I have written I would mention what you have said with regard to the projects being to a large extent separate, most of the assumptions getting the 8 marks relate to standard assumptions in the option pricing model.
Obviously part (c) is really independent and there are some very obvious clues in the question as to points to make towards getting the 10 marks.
(And the 4 presentation marks are easy marks).
It is very hard, if not impossible, for anyone to get full marks on this question or on any Question 1 in the exam. However, if you get used to how the examiner allocates marks, and you make sure that you do something for each part of the question (even if you get stuck somewhere or are short of time), then it is not hard to get the 50% of the marks that you need to be able to pass 🙂
Dear Sir,
Can you please explain why was the initial value of investment (60m) took together with the net present value (10m) to calculate asset value for Jigu project? In the study text it was specificly mentioned that in calculation of Pa we are takin in to account future cash flows from the project EXCLUDING any inital investmen? Isn’t this 60 m actualy initial investment?
Thank you very much in advance.
Pa is indeed the PV of the future cash flows.
If the NPV is 10M and the initial investment was 60M, then the PV of the future cash flows must be 70M. (70 – 60 = 10, which is the NPV)
Ahaaaa, 10 is NPV and not PV. So simple, I did not read it correctly. Thank you 🙂
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