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 $17.5M (at the start) and $17.7M (one year later) at any time in the next 3 years. The option expires at the end of year 3. JTM's discount rate is 13%. What is the NPV of the gate purchases if it bought them today? Use the data in the template above.

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 3-year option 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 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 3-year maturity and a 10% price volatility for gate prices

4. you 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?

O Chrome - Mail - Collier, Chelsea - Outlook A outlook.office365.com/mail/deeplink , Edit and reply I Download EI Show email Excel Week 3 template-1.xls P Find Print Excel Week 3 template-1 EA Data v Comments A G I K JTMAirlines ates: iscount rate 13.0% 3 sk-free rate 8.0% 4 Scenario: No Real Options 3 10 11 12 13 14 15 6. 7 ash from Operations 4.2 11.9 12.9 9.4 8.1 8.0 9.8 12.8 15.9 15.2 14.9 14.6 15.5 16.6 15.2 0.1 8 inus: Capital Expenditures 17.5 9 Net Cash Flow 17.7 5.3 4.1 3.5 1.3 0.1 0.3 8.1 _(0.1) 0.2 0.1 67.8 10 rminal Value V of NCF 11 Scenario: Real Options Option Pricing: PV of Cap. Ex. (Ys. 1-2) 12 2 3 10 11 12 13 14 15 13 14 ash from Operations 15.9 14.6 16.6 4.2 11.9 12.9 9.4 8.1 8.0 9.8 12.8 15.2 14.9 15.5 15.2 Maturity 3.0 0.2 PV of NCF 15 inus: Capital Expenditures 16 Net Cash Flow 5.3 4.1 3.5 1.3 0.1 0.3 0.1 8.1 (0.1) 0.1 Risk free rate 67.8 Volatility 10% 17 rminal Value V of NCF BS calculations: 18 #DIV/O! 19 V of Cap. Ex. (s. 1-2) d1 #DIV/0! #DIV/0! N(d1) 20 d2 21 #DIV/O! N(d2) 22 #DIV/0 Drico of cll Prob. 3 Prob. 1 Prob. 2 Help Improve Office I 10:25 O Chrome - Mail - Collier, Chelsea - Outlook A outlook.office365.com/mail/deeplink , Edit and reply I Download EI Show email Excel Week 3 template-1.xls P Find Print Excel Week 3 template-1 EA Data v Comments A G I K JTMAirlines ates: iscount rate 13.0% 3 sk-free rate 8.0% 4 Scenario: No Real Options 3 10 11 12 13 14 15 6. 7 ash from Operations 4.2 11.9 12.9 9.4 8.1 8.0 9.8 12.8 15.9 15.2 14.9 14.6 15.5 16.6 15.2 0.1 8 inus: Capital Expenditures 17.5 9 Net Cash Flow 17.7 5.3 4.1 3.5 1.3 0.1 0.3 8.1 _(0.1) 0.2 0.1 67.8 10 rminal Value V of NCF 11 Scenario: Real Options Option Pricing: PV of Cap. Ex. (Ys. 1-2) 12 2 3 10 11 12 13 14 15 13 14 ash from Operations 15.9 14.6 16.6 4.2 11.9 12.9 9.4 8.1 8.0 9.8 12.8 15.2 14.9 15.5 15.2 Maturity 3.0 0.2 PV of NCF 15 inus: Capital Expenditures 16 Net Cash Flow 5.3 4.1 3.5 1.3 0.1 0.3 0.1 8.1 (0.1) 0.1 Risk free rate 67.8 Volatility 10% 17 rminal Value V of NCF BS calculations: 18 #DIV/O! 19 V of Cap. Ex. (s. 1-2) d1 #DIV/0! #DIV/0! N(d1) 20 d2 21 #DIV/O! N(d2) 22 #DIV/0 Drico of cll Prob. 3 Prob. 1 Prob. 2 Help Improve Office I 10:25