This preview shows page 1. Sign up to view the full content.
Mini Case:
13  17
We explain how to calculate P and
σ
2
below.
Just as the price of a stock is the present value of all the stock’s future cash flows, the
“price” of the real option is the present value of all the project’s cash flows that occur
beyond the exercise date.
Notice that the exercise cost of an option does not affect
the stock price.
Similarly, the cost to implement the real option does not affect the
current value of the underlying asset (which is the PV of the project’s cash flows).
It
will be helpful in later steps if we break the calculation into two parts.
First, we find
the value of all cash flows beyond the exercise date discounted back to the exercise
date.
Then we find the expected present value of those values.
Step 1: Find the value of all cash flows beyond the exercise date discounted back to
the exercise date.
Here is the time line.
The exercise date is year 1, so we discount
all future cash flows back to year 1.
0
This is the end of the preview. Sign up
to
access the rest of the document.
This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
 Spring '08
 Staff

Click to edit the document details