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Dear Sir,
In BSOP questions the idea is that the project’s NPV is ie. $(0,5) mln + the value of option to delay, say $2mln, total = $1,5mln so recommendation for the project is “go”.I am wondering, because the value of the option is not a real cash flow, is it? Does it really “add” value?
Without the option the NPV is based on expected cash flows and there is a risk because things might turn out to be better or might turn out to be worse.
With an option (depending obviously on the type of option – option to withdraw etc.) you can stay in if things are better but pull out if things are worse. Without the option you would have to say in regardless.
That is what makes the option more valuable.
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