Real option - A venture capitalist is considering taking 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. Clearly, the project is out-of-the-money at the moment. Nevertheless, whats special about this project is the agreement that he can sell his share of the ownership to other partners anytime in the next 10 years (t = 10), for $7.5 million. The variance in the PV of cash flows from being in the partnership is high and calculated as 0.09. The 10-year risk-free rate is assumed as 3% per year. (Rf = 0.03). Assume that the project does not depreciate over time.

N(1.0397) = 0.8508 N(1.1495) = 0.8748 N(1.3578) = 0.9127 N(0.4582) = 0.6766 N(0.0911) = 0.5363 N(0.0547) = 0.5218

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Question 22 Continued Over...

...Question 22 Continued:

N(0.0288) = 0.5115 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 to abandon the project for the venture capitalist. Is the value of real option high enough to compensate for its negative NPV?