a. JTM Airlines, where you work, is looking at potentially buying more gates at their home airport. If it pays the airport $1M, JTM will hold exclusive rights to buy those gates for $17M (at the start) and $17.5M (one year later) at any time in the next 4 years. The option expires at the end of year 4. JTM's discount rate is 10%. What is the NPV of the gate purchases if it bought them today?

b. After you run the numbers for part A, you remember back to your ERAU corporate finance class's coverage of real options. You know that the 4-year option has value, so you decide to calculate it by:

1. Present valuing the purchase price of the gates separately using the riskfree rate. Once JTM decides to go ahead with the purchase, there is no risk to that expenditure.

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

3. Using the Black-Scholes Option Pricing formula to come up with option's price assuming a 4-year maturity and a 10% price volatility for gate prices.

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

Please show in excel with formulas.

A B D E F I J K L M N 0 P Q R S G H JTM Airlines 1 10.0% 6.0% 1 2 3 12.9 5.3 4.2 17.0 Scenario: No Real Options 6 7 8 2 8.0 9.8 12.8 15.9 1.3 0.1 0.3 4 9.4 4.1 11.9 17.5 5 8.1 3.5 10 15.2 0.1 11 14.9 8.1 12 14.6 (0.1) 13 15.5 0.2 15 15.2 14 16.6 0.1 67.8 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 1 4.2 2 11.9 3 12.9 5.3 4 9.4 4.1 Scenario: Real Options 7 8 2 9.8 12.8 15.9 0.1 0.3 6 8.0 1.3 8.1 3.5 10 15.2 0.1 11 14.9 8.1 12 14.6 (0.1) 13 15.5 0.2 14 16.6 0.1 15 15.2 67.8 Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity 4.0 PV of NCF Risk free rate 6.0% Volatility 10% BS calculations: di #DIV/0! N(dl) #DIV/0! d2 #DIV/0! N(2) #DIV/0! Price of call #DIV/0! Difference: - Value of Option over PV - % of PV A B D E F I J K L M N 0 P Q R S G H JTM Airlines 1 10.0% 6.0% 1 2 3 12.9 5.3 4.2 17.0 Scenario: No Real Options 6 7 8 2 8.0 9.8 12.8 15.9 1.3 0.1 0.3 4 9.4 4.1 11.9 17.5 5 8.1 3.5 10 15.2 0.1 11 14.9 8.1 12 14.6 (0.1) 13 15.5 0.2 15 15.2 14 16.6 0.1 67.8 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 1 4.2 2 11.9 3 12.9 5.3 4 9.4 4.1 Scenario: Real Options 7 8 2 9.8 12.8 15.9 0.1 0.3 6 8.0 1.3 8.1 3.5 10 15.2 0.1 11 14.9 8.1 12 14.6 (0.1) 13 15.5 0.2 14 16.6 0.1 15 15.2 67.8 Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity 4.0 PV of NCF Risk free rate 6.0% Volatility 10% BS calculations: di #DIV/0! N(dl) #DIV/0! d2 #DIV/0! N(2) #DIV/0! Price of call #DIV/0! Difference: - Value of Option over PV - % of PV