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Principles of Corporate Finance – A Tale of Value Week 6 The valuation of a real investment project – analyzing Prev Home

Financial Managementexam purposes, it can be

Lectures assumed that real options are European-style options,
which can be exercised at a particular time in the future
Reading and their value will be estimated using the Black-Scholes
Option Pricing (BSOP) model and the put-call parity to
Assignments
estimate the option values. However, assuming that the
Discussion Prompt: option is a European-style option and using the BSOP
Open Question 6 model may not provide the best estimate of the option’s
5 min
value (see the section on limitations and assumptions
Quiz: Final Test
below).Five variables are used in calculating the value of
14 questions real options using the BSOP model as follows:

1. The underlying asset value (Pa), which is the

Peer-graded
Assignment: The present value of future cash flows arising from the
valuation of a real project.
investment project – 2. The exercise price (Pe), which is the amount paid
analyzing inputs, when the call option is exercised or amount
scenarios, sensitivity, and
received if the put option is exercised.
timing
3. The risk-free (r), which is normally given or taken
Grading in progress
from the return offered by a short-dated
Review Your Peers: The government bill. Although this is normally the
valuation of a real discrete annualised rate and the BSOP model uses
investment project – the continuously compounded rate, for Advanced
analyzing inputs,
Financial Management purposes the continuous
scenarios, sensitivity, and
timing and discrete rates can be assumed to be the same
when estimating the value of real options.
4. The volatility (s), which is the risk attached to the
project or underlying asset, measured by the
standard deviation.
5. The time (t), which is the time, in years, that is left
before the opportunity to exercise ends.