Page 169 - AFM Integrated Workbook STUDENT S18-J19

Option pricing

d =0.3196 – 0.25 3
2
= -0.1134 (so -0.11 to 2 decimal places)

From tables N(d 1) = 0.5 + 0.1255 = 0.6255, and N(d 2) = 0.5 - 0.0438 = 0.4562

Therefore, call option value = 1.8 × 0.6255 – 2 × 0.4562 × e -0.05×3

= 1.126 – 0.785 = $0.341 million

This means that the “strategic NPV” of undertaking the first project is:

–$0.2 million + $0.341 million = $0.141 million

This is a positive value, so the initial project is financially viable once the
follow-on option is also considered.

Illustrations and further practice

Now try Illustration 6 and TYU 7 from Chapter 8

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