Capital Holdings Ltd. (CP) is seeking a joint venture partner to manufacture and market a product it has developed. It has approached Aplet Products Plc. (AP), a large consumer goods firm with a proposal to invest 10m as a 50% shareholder in the joint venture, NewCo Ltd., which would be expected to have a life of 10 years. AP has analysed the investment proposal and determined that there is significant uncertainty about the expected cash-flows. A net present value (NPV) analysis conducted by AP indicates the project has a negative NPV of -1.1m and AP have turned down the proposal. CP remains extremely confident in the project however and has offered to buy out APs shareholding for 8.5m after three years if AP wishes to divest itself of its shareholding at that point. Additional Information - The volatility of ordinary shares in consumer goods companies is 21% per year (standard deviation). - NewCo Ltd. is not expected to generate dividends in it first three years of operation. - The risk free rate is 4.5% Required: (i) Identify the real option in this project and map the variables used for Black-Scholes option pricing onto this project. (ii) Estimate the value of the real option using the Black-Scholes option pricing model and write a brief report recommending whether AP should invest in NewCo Ltd. on the terms proposed by CP and explaining the rationale for your recommendation.