Real Options:

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? Use the data in the Excel template provided.

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?

Here is my work thus far:

I need help with the far-right side of the spreadsheet that is blank or says #DIV/0!. Thank you in advance and please show your formulas.

A B D E F G H I J K L M N O P R S 1 JTM Airlines 2 3 Rates: Discount rate Risk-free rate 10.0% 6.0% 4 5 1 4.2 17.0 2 11.9 17.5 3 12.9 5.3 4 9.4 4.1 Scenario: No Real Options 6 7 8 9 8.0 9.8 12.8 15.9 1.3 0.1 0.3 5 8.1 3.5 4.6 10 15.2 0.1 11 14.9 12 14.6 (0.1) 14.7 13 15.5 0.2 15 15.2 14 16.6 0.1 8.1 (12.8) (5.6) 7.6 5.3 6.7 9.7 12.5 15.9 15.1 6.8 15.3 16.5 15.2 67.8 58.8 1 4.2 2 11.9 3 12.9 5.3 4 9.4 4.1 5 8.1 3.5 6 8.0 1.3 Scenario: Real Options 7 8 9 9.8 12.8 15.9 0.1 0.3 9.7 12.5 15.9 10 15.2 0.1 13 15.5 0.2 15 15.2 6 7 Cash from Operations 8 minus: Capital Expenditure: 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 11 14.9 8.1 6.8 14 16.6 0.1 4.0 12 14.6 (0.1) 14.7 4.2 11.9 7.6 5.3 4.6 6.7 15.1 15.3 16.5 15.2 67.8 6.0% 10% 88.7 29.9 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! 27