Novo Technica (NT) is a technology manufacturing company. Union Manufacturing (UM), another manufacturing company, has approached NT with a proposal. NT and UM will jointly finance a project to produce and market a new "smart" electricity meter. The project would require an investment of €10,000,000 each from both NT and UM. NT has considered the proposal and based on forecasted demand for the product has estimated that its €10,000,000 investment would generate a negative Net Present Value of (€500,000). On this basis, NT has declined to invest. UM is very confident about the project however and has offered to buy out NT's stake in the project after 3 years for €6,800,000 should NT wish to exit the investment. Volatility (standard deviation) in returns from technology manufacturing is estimated at 30% per year. The risk free rate of return is 1.5%. NT is now considering this revised proposal.

 

(i) Explain how the real option available to NT could be valued using the Black-Scholes model and how would i map the project characteristics onto the Black-Scholes variables.