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hi
Could you please advise on the following:
1.option to delay:
If the value of the project without option is £1m
Value of the option is £3m
Is the value of the project with option to delay £3m or £3m+£1m=£4m?
I believe in the example in the Chapter 14 you add option to the NPV of the project without option
In the acca article ‘Investment appraisal and real option’ the author takes an option value instead of the NPV initial project
2. option to expand
if there is an option to expand in 4 years.
the amount I will need to spend in 4 years is £100m and CFs (assume) year 5 £50m.
Do I need to discount both the spend of $100m and the cash inflow of £50m to year 0 (find their current value)?thank you
1. The value of the project with the option to delay is $3M.
I need to re-record the lecture. It was based on the first exam question that was asked on the calculations of real options, which was set by the previous examiner. He answered it just as do in the lecture.
However recently the current examiner realised that what the previous examiner did was wrong, which is why the technical article appeared.
(Kaplan has amended their answer to the exam question accordingly, but BPP still show the original (wrong) answer. I will be re-recording the lecture soon.)2. $100M is Pe and is not discounted (the Black Scholes formula is effectively doing the necessary discounting in the e^-rt part)
Thank you.
Am I right thinking that the previous examiner also did not move years 1-4 cash inflows to years 3-6 for discounting purpose? (option to delay for 2 years)I am trying to compare the article and June 2011 Q4 answer (which then appears to be completely wrong in this case)
Actually I am a bit confused about which question you are writing about 🙂
The question I was referring to (by the previous examiner) was Digunder. The question MMC was set by the current examiner.
In both cases the discounting is correct. In MMC cash flows inflows were never going to arrive in years 1 to 4 – they are the flows for four-year sales period but the sales period does not start until the development is complete, which takes 2 years. So the two years are nothing to do directly with the option to delay.
sorry.
The example of moving CF from years 1-4 to 3-6 for option to delay is from the article.
I was referring to MMC and now I see my mistake in regards to CFs there.
However, you said MMC question was set up by a new examiner but it does add the value of the option to the value of initial project. What do I miss here? is it an error or there are cases when we should add them up and there are cases when we should substitute the project value without the option by the project value with option?
Thank you
Yes – he did it wrong as well 🙂
I was told he was going to correct the answer on the ACCA website, but I just checked and he obviously hasn’t done it yet!
Hi John
in first reply of your’s u mentioned that the value of the project with the option to delay is 3m whereas project’s npv is 1m without the option , so does it mean that the value of option is 2m while the project’s npv being 1m.Or when we take option to delay , so we ignore the npv of the project altogether and the value of real option ie 3m becomes the ultimate value of the project.
Hello in regards to Digunder ,Pa was(NPV 4+24execise price),however from what you wrote above,you. Are saying this is wrong right??
Please what is the right way? Thank you
Pa in the answer is 28M (it was not what you have typed) and that is correct – I have certainly not said that that is wrong.
The NPV without the option is $4M.
The NPV with the option is $7.53M (from the Black Scholes formula)
The value of the option is the difference of $3.53M.
(It is only that last bit that is wrong in the examiners answer and in BPP’s answer (although apparently Kaplan now have corrected their answer))
hello!
can I be assisted on the computation of e^-rt part,e.g on question No.4 of june 11 exam e^(-0.05×2) gives 0.9322. I do not know how to arrive at that figure.thanks
I assume that you have a scientific calculator and therefore you have an ‘e’ button.
The problem is that there are two types of logic for calculators and which buttons you press in which order depends on the calculator.
If you watch my free lectures on options I explain which buttons to press on my calculator, however yours might use different logic and you really need to look at the instruction manual for the calculator.
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