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PRINCIPLES OF CORPORATE FINANCE

6th Edition
RICHARD A. BREALEY AND STEWART C. MYERS

Chapter 4
Time Value of
Common Stocks
2. Graph the put and call over a range of stock prices.

FOLLOW-ON INVESTMENT OPPORTUNITIES

1. Use the B-S formula to value the Blitzen Mark II follow-on option in Table 21-2. Using
the following values:

Std Dev = 0.35; Risk-free rate = 9.53%; Exercise Price = 900;


Initial Asset Value = 463; and t = 3.000 years.
Note: the text uses the nearest reported figure in Appendix Table 6,
which differs by $1.5 million from the value calculated herein.

2. What happens to the value of the option as the forecast of future cash flows is reduced to
million? $600 million?

3. Vary the standard deviation (assuming the project's PV does not change). Note that the
more uncertain the project value, the more valuable the follow-on option.

4. Graph what happens to the value of the option as the decision date to invest grows near but
the cash flow forecast remains unchanged.
Value of Call Option
at Different Stock Prices

60
50 Time to Expiration
Value of Call Option

= 3 Years Upper Bound


40
30 Exercise
Price =
20 $35.00
Lower Bound
10
0
-10
0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00
Stock Price
Value of Puts and Calls Over
Value of Put and Call Options

Varying Present Stock Prices

00
8.
00
6.
00
4.
00
2.
00
0. 15.00 20.00 25.00 30.00 35.00 40.00 45.00 50.00 55.00 60.00 65.00
Present Price of Stock
Value of a Call as Expiration Date Nears

18
16

Value of Call Option


14
12
10
8
6
4
2
0
3.375 3.000 2.625 2.250 1.875 1.500 1.125 0.750 0.375 0.000
Time to Expiration