Page 167 - AFM Integrated Workbook STUDENT S18-J19

Option pricing

To use the BSOP model we need to identify the five key input variables.

‘P a’ is the PV of the future

‘P e’ for a call option is the cash flows from the project
capital investment required. (excluding any initial
‘P e’ for a put option is the investment) i.e. value of the
salvage value on project being undertaken

abandonment (call), or value of the cash
flows foregone (put)

‘t’ is easy to 5 key variables ‘s’ can be
pick up if the measured using
project involves
a single typical industry
sector volatility
investment
‘r’ is still the risk-free rate,

(but there is an argument
that says a higher rate
should be used to reflect
risk of the project)

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