You have a proposal with a negative NPV. Chief executive of your firm thinks that the project may be worthwhile. He argues that we should conduct the project in phases. Phase 1 will be undertaken now and phase II will be four years down the road. If conditions are favourable, such follow on investment can be very profitable

Sensing the possibility of applying the option pricing model for valuing the option to make the follow on investment, you collect the following information.

•Phase II will require an investment of 300 million

•Present value of the phase II assets is 129 million

•You look at the stock price behaviour of  your company and find that it has a standard deviation of 40 percent.

•Risk free rate of return is 12 percent

Use Black Scholes Model and find out the value of the option.

Answer rating: 100% (QA)

Given the situation the option to undertake Phase II investment can indeed be analyzed somewhat like ... View the full answer