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(DR. GERALD POLLIO)
Lag time of the project
= 2 Years
Dividend Yield or Net production revenue
= 5% of reserves
Current value of the asset: As the current value of the asset must reflect the loss of
production revenues during the delay or the lag time, value of the asset will be
discounted back at dividend yield (δ) for 2 years. This reflects the loss of cash flow
during developmental period. Therefore current value of oil fieldo
S= $12 x 50,000 x(
= $ 544.22 millions
K= Exercise price = Developmental cost = $ 600 millions
T= Time to expiration
= 20 years
R= Risk free interest rate
The firms that make natural resource investments have the option to leave the
investments untouched if the price of the resource declines and to exploit them fully if
the price rises. Therefore, extracting the reserves make sense only if the value of
reserves exceeds the development cost. Therefore, a natural resource investment can
be viewed as a call option where the underlying asset is the reserve and the value of
the reserve depends on the quantity and price of the natural resource.
Underlying offshore oil property offers production revenue of 5% of the 50 million
barrels of reserves ever year which is the dividend yield of the asset. As payment of
dividend reduces the assets’ price; the call option under consideration will become
less valuable due to 5% dividend yield on its .
Typical Black- Scholes Model applies to the assets which do not pay dividends over
their life, therefore it do incorporate the effect of dividend yield on interest rate as
well as loss of revenue at dividend yield for the duration of developmental work.
Following adjusted Black and Scholes Model will incorporate this. (Bodie, et al; 2008
p 758), (Mun, J, 2002), (Wikipedia link provided)
BLACK SCHOLES MODEL
For non-dividend paying option the call value is calculated by following expression.