Ch13 - = 28.89/74.61 = 0.39 Now use the following formula...

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CHAPTER 13 Option Pricing with applications to real options
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K. K. The option to wait resembles a financial call option. The current expected present value, P, is P = 0.3[$111.91/1.1]+0.4[$74.61/1.1]+0.3[$37.30/1.1] = $67.82. The direct approach gives an estimate of 18.2% for the variance of the project’s return : = 0.3(0.65-0.10)²+0.4(0.10-0.10)²+0.3(-0.45-0.10)² = 18.2% You can also use the indirect approach to estimate the variance of the project's rate of return. Start by estimating the coefficient of variation, CV, of the project's value at the time the option expires. 2 σ
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K. K. (Continued) (Continued) CV = Standard Deviation of Value/Expected Value
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Unformatted text preview: = 28.89/74.61 = 0.39 Now use the following formula to estimate the variance of the project's rate of return : =14.2% Next, we use Black-Scholes formula (using 14.2 % as estimated variance) : D1 = 0.2641 and D2 = -0.1127 Therefore, V = $67.83 (0.6041) - $70 (0.4551) = $ 10.98 t ] 1 CV ln[ 2 2 + = σ 2 σ 0.06 e-N. N. P = 0.3 [$111.91/1.1³]+0.4[$74.61/1.1³]+0.3[$37.30/1.1³] = $56.05 = 2.3% (direct approach) = 4.7% (indirect approach) (Using 4.7% as estimated variance) D1 = -0.1085 and D2 = -0.484 Therefore, V = $5.92 TOTAL VALUE = -0.39 + 5.92 = $ 5.5 2 σ...
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This note was uploaded on 11/16/2009 for the course F 3033 taught by Professor Hh during the Spring '09 term at Maastricht.

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Ch13 - = 28.89/74.61 = 0.39 Now use the following formula...

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