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Appendix 2 (Part (b) (ii):
Jigu Project: Asset value
Asset value of Jigu Project of $46,100,000 is estimated as present value of future cash flows related to the project:
$70,000,000 x 1·11–4, where $70,000,000 = $60,000,000 + $10,000,000.
Honua Co offer, initial variables used to calculate the d1, d2, N(d1) and N(d2) figures:
Asset value (Pa) = $16,959,000 + $19,488,000 = $36,447,000 (cash flows foregone)
Exercise price (Pe) = $30,000,000
Exercise date (t) = 2 years
Risk-free rate (r) = 2·30%
Volatility (s) = 30%Value of Honua Co offer
Value of Honua Co’s offer
Call value: $36,447,000 x 0·7821 – $30,000,000 x 0·6387 x e(–0·023 x 2) = $10,205,640
Honua Co’s offer is equivalent to a put option.
Put value: $10,205,640 – $36,447,000 + $30,000,000 x e(–0·023 x 2) = $2,409,899
Estimated total value arising from the two real options
Value of Jigu Project: $15,258,399
Value of Honua Co’s offer: $2,409,899
Estimated total value from the two real options: $2,409,899 + $15,258,399 = $17,668,298Question ))
1. Jingu projects asset value : what is the meaning of the asset value. 70M is the pv of ( cash inflow) in 4 years. Asset value means NPV+ Initial cash outlay ?2. Estimated total value arising from the two real options
Value of Jigu Project: $15,258,399
I have no clue how to produce this figure.I found it difficult regarding part b (II) genenrally. pls help me.
(ii) Addresses the requests made by the finance director about the initial variables and estimated value of the offer from Honua Co using the real options method;
Q) I could not understand even the question. about the initial variables?? how should I deal with it?? I just realised the value of Jigu project is the given call option value. I understand all figures in the model answer but I could not get a clear picture of it regarding the question whole. Thank you very much. Through of the question, I would like to master a real option question. thank you.
1. The value of any assets is always the present value of the future cash flows.
For the Jigu project the cost is $60M and the NPV is $10M and therefore the PV of the future flows must be $70M. However this is all in 4 years time, and so the PV ‘now’ is $70M discounted for 4 years.2. The value of the Jigu project (15,258,399) is given in the question.
3. In order to calculate d1 and d2, we use the formulae on the formula sheet and the formulae need Po, Pe, t, r and s. This question does not require the calculations of d1 and d2, but require you to state the values of these variables that would be used in the formulae. I explain all of these variables in my lectures on option pricing and on real options.
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