2. Real Options DC Airlines is looking at expanding its operations in Burbank airport. The airport's management has given it a 5-year option on the expansion. The project has the following financials: Initial cash from operations - $3M Cash yearly growth rate - $0.5M Discount rate - 9% Capital expenses (yrs. 1-5) - $11M/year and $1M/year (yrs. 6-15) Risk-free rate - 4% Terminal value - $23M Volatility - 5% Maturity - 5 years What is the NPV of the No Real Options Scenario and the Real Options Scenario? What is the price of the 5-year call option? What is the value of the option over the Real Option Scenario NPV? DC Airlines 2 Rates: 3 Discount rate 4 Risk-free rate 5 Cash yearly growth rate (M$) 6 Scenario: No Real Options 9 10 11 12 13 14 15 Scenario: Real Options 8 9 6 10 11 12 13 14 15 8 Cash from Operations 9 minus: Capital Expenditures 10 = Net Cash Flow 11 Terminal Value 12 PV of NCF 13 14 15 Cash from Operations 16 minus: Capital Expenditures 17 = Net Cash Flow 18 Terminal Value 19 PV of NCF 20 PV of Cap. Ex. (Yrs. 1-5) 21 PV net of Cap. Ex. Option Pricing: PV of Cap. Ex. (Yrs. 1-5) Maturity PV of NCF Risk free rate Volatility BS calculations: #DIV/0! Nd1) #DIV/0! #DIV/0! N(42) #DIV/0! Price of call #DIV/0! Difference: - Value of Option over PL - % of PV 2. Real Options DC Airlines is looking at expanding its operations in Burbank airport. The airport's management has given it a 5-year option on the expansion. The project has the following financials: Initial cash from operations - $3M Cash yearly growth rate - $0.5M Discount rate - 9% Capital expenses (yrs. 1-5) - $11M/year and $1M/year (yrs. 6-15) Risk-free rate - 4% Terminal value - $23M Volatility - 5% Maturity - 5 years What is the NPV of the No Real Options Scenario and the Real Options Scenario? What is the price of the 5-year call option? What is the value of the option over the Real Option Scenario NPV? DC Airlines 2 Rates: 3 Discount rate 4 Risk-free rate 5 Cash yearly growth rate (M$) 6 Scenario: No Real Options 9 10 11 12 13 14 15 Scenario: Real Options 8 9 6 10 11 12 13 14 15 8 Cash from Operations 9 minus: Capital Expenditures 10 = Net Cash Flow 11 Terminal Value 12 PV of NCF 13 14 15 Cash from Operations 16 minus: Capital Expenditures 17 = Net Cash Flow 18 Terminal Value 19 PV of NCF 20 PV of Cap. Ex. (Yrs. 1-5) 21 PV net of Cap. Ex. Option Pricing: PV of Cap. Ex. (Yrs. 1-5) Maturity PV of NCF Risk free rate Volatility BS calculations: #DIV/0! Nd1) #DIV/0! #DIV/0! N(42) #DIV/0! Price of call #DIV/0! Difference: - Value of Option over PL - % of PV