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Hi,
Just a question on real options.
Is the value of the option as per the Black and Scholes only the value of having the right to delay/abandon, etc?
The June 2011 – question 4 – Mesmer Magic examiner’s answer takes the call option price as just the value of the option to delay.
However, in December 2007 – question 3 – Digunder examiner’s answer and the answer in the Kaplan revision kit (Q38) are different. Kaplan takes the value of the option to also include the intrinsic value of the project (like how for share options we break down the value of the option to the intrinsic value and time value).
So what is right?
Do we always add the option value to the project NPV (without option) to get the total underlying value?
But then how come it differs when we value share options which already includes the intrinsic value?With share options, you are buying the right to deal in the share at a fixed price and the formula calculates how much it will cost to buy this right.
With real options, the situation is slightly different. ‘Normal’ projects do not give you the option to delay etc. and therefore the value of the project is simply the NPV as normal. However, if the project gives you the option to delay etc. in addition, then it makes the project more valuable – the option itself has value. So…..the full value is the NPV plus the extra value of the option (as given by the formula).
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