b) Planet ltd is considering undertaking a 20 year project which requires an initial investment of sh.250 million in real estate partnership whose present value (PV) of expected future cash flows is sh.254 Million. Planet Ltd has the option to abandon the project after five years for sh.150 Million. The variance in the present value(PV) of the cash flows is 0.09 and the 5- year risk free rate of return is 7 %.

Required:

1)The Net present value of the project including the value of an option to abandon the project (8 Marks)

2)Comment on the results of your analysis in (b)(i) above (2 Marks)

Note: 1.The Black Scholes option pricing model C = PaN(d1) Pe(e)-rt N (d2) Where,

d1 = ln(Pa/Pe) +( r + 0.52 ) t t

d2 = d1 - t 2.

The Put Call parity relationship: P = C Pa + Pe(e)-rt