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 $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% and the risk-free rate is 3%. What is the NPV of the gate purchases if it bought them today? Use the data in the Excel template provided

B. After you run the numbers for part A, you remember back to your 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 options price 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 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?

IMPORTANT: SHOW FORMULAS USED TO CALCULATE

JTM Airlines Rates: Discount rate Risk-free rate 6.5% 3.0% 1 5.0 9.0 2 5.2 9.0 3 5.3 3.0 4 6.0 4.0 5 7.0 3.0 Scenario: No Real Options 6 7 8 9 8.0 9.0 10.0 11.0 2.0 1.0 0.5 10 12.0 0.1 11 13.0 3.0 12 14.0 3.0 13 15.0 0.2 14 16.0 0.1 15 17.0 Cash from Operations minus: Capital Expenditures = Net Cash Flow Terminal Value PV of NCF 67.8 1 5.0 2 5.2 3 5.3 3.0 4 6.0 4.0 5 7.0 3.0 6 8.0 2.0 Scenario: Real Options 7 8 2 9.0 10.0 11.0 1.0 0.5 10 12.0 0.1 11 13.0 3.0 12 14.0 3.0 13 15.0 0.2 14 16.0 0.1 15 17.0 3.0 Cash from Operations minus: Capital Expenditures = Net Cash Flow Terminal Value PV of NCF PV of Cap. Ex. (Yrs. 1-2) 67.8 20% Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity PV of NCF Risk free rate Volatility BS calculations: d1 N(1) d2 N(42) Price of call Difference: - Value of Option over PV - % of PV #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! JTM Airlines Rates: Discount rate Risk-free rate 6.5% 3.0% 1 5.0 9.0 2 5.2 9.0 3 5.3 3.0 4 6.0 4.0 5 7.0 3.0 Scenario: No Real Options 6 7 8 9 8.0 9.0 10.0 11.0 2.0 1.0 0.5 10 12.0 0.1 11 13.0 3.0 12 14.0 3.0 13 15.0 0.2 14 16.0 0.1 15 17.0 Cash from Operations minus: Capital Expenditures = Net Cash Flow Terminal Value PV of NCF 67.8 1 5.0 2 5.2 3 5.3 3.0 4 6.0 4.0 5 7.0 3.0 6 8.0 2.0 Scenario: Real Options 7 8 2 9.0 10.0 11.0 1.0 0.5 10 12.0 0.1 11 13.0 3.0 12 14.0 3.0 13 15.0 0.2 14 16.0 0.1 15 17.0 3.0 Cash from Operations minus: Capital Expenditures = Net Cash Flow Terminal Value PV of NCF PV of Cap. Ex. (Yrs. 1-2) 67.8 20% Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity PV of NCF Risk free rate Volatility BS calculations: d1 N(1) d2 N(42) Price of call Difference: - Value of Option over PV - % of PV #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0