Question11

Real option - As a venture capitalist you are considering an investment opportunity to invest in a 10-year project that requires an initial investment of $10 million in new product partnership. As of now, the expected PV of this project is estimated as only $9.5 million. Nevertheless, what's special about this project is the agreement that you can sell your share of the ownership to other partners anytime in the next ten years (fixed and guaranteed), for $7.5 million. The variance in the PV of cash flows from being in the partnership is moderate and calculated as 0.04. The 10-year risk-free rate is assumed as 3% per year. This project value decay in time with the rate of 5% per year).

N(1.0397) = 0.8508

N(0.3738) = 0.6457

N(1.3578) = 0.9127

N(0.4582) = 0.6766

N(0.0911) = 0.5363

N(0.0547) = 0.5218

N(-0.2587) = 0.3979

N( d1=?) = 0.90

N( d2=?) = 0.55

Note:In the case you could not find N(d) that matches your d1 and d2, please use N(d1=?) and N(d2=?). However, please indicate exact numbers you get for d1 and d2.

Required:

Calculate the value of real option embedded in this project. Is the value of real option high enough to make this investment worthwhile?

(Please upload written answer as a text)