2.Real Optionsa.JTM Airlines, where you work, is looking at potentially buying more gates at theirhome airport. If it pays the airport $1M, JTM will hold exclusive rights to buy thosegates for $9M (at the start) and $9M (one year later) at any time in the next 3years. The option expires at the end of year 3. JTM's discount rate is 6.5% andthe risk free rate is 3%. What is the NPV of the gate purchases if it bought themtoday? Use the data in the Excel template provided.b.After you run the numbers for part A, you remember back to your ERAUcorporate finance class's coverage of real options. You know that the 3-yearoption has value, so you decide to calculate it by:

1.Present valuing the purchase price of the gates separately using the risk-free rate. Once JTM decides to go ahead with the purchase, there is norisk to that expenditure.

2.Present valuing the Net Cash Flow excluding those purchase prices. Thiscalculation will include Cap. Ex. for years 3-15 as they are part of thenormal operation of the gates and are unrelated to the purchase price.

3.Using the Black-Scholes Option Pricing formula to come up with option'sprice assuming a 3-year maturity and a 20% price volatility for gate prices.

4.Compare the price of the call option as calculated using the BSO formulawith the NPV in the No Real Options scenario. With this, you can decidewhether or not the $1M option is worth it or not. Is it?

IMPORTANT: SHOW FORMULAS USED TO CALCULATE

D E F I J K L M N o P G H JTM Airlines Q R S Scenario: No Real Options 6 7 8 9 1 2 3 4 5 10 11 12 13 14 15 Scenario: Real Options 7 8 9 1 2 3 4 5 6 10 11 12 13 14 15 1 2 Rates: 3 Discount rate 4 Risk-free rate 5 6 7 Cash from Operations 8 minus: Capital Expenditures 9 = Net Cash Flow 10 Terminal Value 11 PV of NCF 12 13 14 Cash from Operations 15 minus: Capital Expenditures 16 = Net Cash Flow 17 Terminal Value 18 PV of NCF 19 PV of Cap. Ex. (Yrs. 1-2) 20 21 22 23 24 25 26 27 Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity PV of NCF Risk free rate Volatility BS calculations: di Nd1) d2 N(42) Price of call Difference: - Value of Option over PV % of PV #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! D E F I J K L M N o P G H JTM Airlines Q R S Scenario: No Real Options 6 7 8 9 1 2 3 4 5 10 11 12 13 14 15 Scenario: Real Options 7 8 9 1 2 3 4 5 6 10 11 12 13 14 15 1 2 Rates: 3 Discount rate 4 Risk-free rate 5 6 7 Cash from Operations 8 minus: Capital Expenditures 9 = Net Cash Flow 10 Terminal Value 11 PV of NCF 12 13 14 Cash from Operations 15 minus: Capital Expenditures 16 = Net Cash Flow 17 Terminal Value 18 PV of NCF 19 PV of Cap. Ex. (Yrs. 1-2) 20 21 22 23 24 25 26 27 Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity PV of NCF Risk free rate Volatility BS calculations: di Nd1) d2 N(42) Price of call Difference: - Value of Option over PV % of PV #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0