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John,
I often confused some below issue relevant to the this topics
+ When we need to discount Pa and Pe in BSOP model
+ To a call option, for example: if we do the project, the NPV is 50M, if we value the project with option, the value of the option shall be 60M, so which value is relevant to add the business in order to derive a business value as a whole, the NPV, the option value or both two value, pls. advise
Thanks
For your first statement, the BSOP formula itself is doing the relevant discounting.
For your second, it is the 60M that is relevant if the option exists.
Dear Sir,
So, I am assuming from this discussion and others about real options. Question Digunder 2007 BPP answer kit is wrong as they are adding both NPV and Options value for the whole project valuedragon: Because the value with the option is greater that that without it.
byron: Yes it is wrong. The BPP answer is a copy of the examiners own answer (it was the previous examiner), but more recently the current examiner has accepted that the answer was wrong.
The value of the option itself is the difference between the NPV without the option, and the value arrived at using the BSOP formula.(For the same reason my lecture is wrong – I (as with everyone) was basing it on the original examiners answer, and I do need to re-record it. Kaplan have now changed the answer in their Revision Kit, but BPP have not done so yet.)
John, is it means that the option value of 60M including the NPV without option 50M already??
I am not sure what you mean by “the principle to the final is the same”.
I means that in the real option : Put option, if the option value is higher than NPV without option, the higher value shall be added to business value, is it right ?
The value with the option will be higher than without the option – correct 🙂
Sorry, It must be something i still do not understand, as in BPP book, in the example Four Season invest in Spain at investment 250M in 20 years with the cash inflow 254M, while the NPV is marginal, FS be offered an option to sales the project to Government at the end of year 5 at 150M, the Risk Free 7%, standard deviation 0.3
the value of the Put option based on BSOP is 4.7M
in conclusion, the Project shall bring to FS is 4+4.7=8.7M, so in this case, the NPV be added to derive the final value but not take a higher one, pls. advise
BPP is wrong. If you read my earlier post I explain that it is because the previous examiner got his real option question wrong!
The current examiner has now corrected it (and the technical article on real options makes it clear) but BPP has not yet changed their answers.The value of the option in your example is 0.7 (4.7 – 4).
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