• We are pleased to announce that the winner of our Feedback Prize Draw for the Winter 2024-25 session and winning £150 of gift vouchers is Zhao Liang Tay. Congratulations to Zhao Liang. If you fancy winning £150 worth of gift vouchers (from a major UK store) for the Summer 2025 exam sitting for just a few minutes of your time throughout the session, please see our website at https://www.acted.co.uk/further-info.html?pat=feedback#feedback-prize for more information on how you can make sure your name is included in the draw at the end of the session.
  • Please be advised that the SP1, SP5 and SP7 X1 deadline is the 14th July and not the 17th June as first stated. Please accept out apologies for any confusion caused.

Chapter 22 - Real options

A

asbes

Member
At the end of chapter 22 there is an example of how to value real options.

The risk neutral probability of success is calculated, given the PV at outset (7m) and the PVs and the end of year one if the project is a success (9m) or a flop (4m).

In practice the 9m and 4m can be calculated by looking at the expected cashflows under the two scenarios (success and flop).

How will the 7m PV at outset be calculated? In the example it is just a given number.

Thanks.
 
Risk neutral

Hi,
I think this question probably goes slightly beyond what appears to come up in SA5 exams (with the benefit of hindsight). The 7m is the PV of the two outcomes using appropriate risk discount rates and real probabilities for each of the two outcomes. So 9* (prob of success) * (1.15)^-1 + 4 * (prob of failure) * (1.15)^-1 would be a typical calculation, where I have selected 15% as a reasonable discount rate.
 
You must log in or register to reply here.
Back
Top