MODEL SELECTION MENU

Modified Black-Scholes Models

Option to Delay a Project

Valuing the option to delay an already valued investment is a commonly applicable and worthwhile exercise. As expected cash flows and
discount rates that drive traditional valuation techniques change over time, so does the net present value. Therefore, while a project may
have a small or negative present value today, it may have a significantly positive present value in the future.
Option to Expand a Project

Investments in projects made today in order to take on projects or enter markets in the future, are essentially options to expand. A negative
present value may be accepted on the initial investment, because of the possibility of high postive net present values on future projects.

Option to Abandon a Project

Not all projects are successful and when cash flows are lower than expected, it is useful to evaluate the option to abandon the project.
While estimation of the liquidation (abandonment) value limits the usefulness of the resulting valuation, understanding the sensitivites can
be a worthwhile exercise.

Advanced Applications
Binomial Option Pricing

The binomial option pricing model is suitable for complex situations where options exist on options in a 'tree' like manner. Furthermore,
while outcomes can be approximated to the normal distribution, this assumption required by the Black-Scholes model can be relaxed with
the binomial model.
Game Theory Analysis

This model utilises real option theory to calculate the value of expected strategy for each of two firms in a competitive environment.
Essentially the model determines the level of cash flows required for each of the following and leading firm to enter the market with the
proposed product. This model is useful for evaluating the proposed investment under a competitive environment.
 The Option to Delay New plant

$100 The PV of expected net cash flows from initiating New plant now (not including up-front investment).
INPUTS: $150 The PV of set-up & development costs to required undertake the project.
Can be 5 The project lifetime, or period during which the project can be undertaken.
adjusted to
alter the 9.0% The equivalent risk-free rate for the project life.
results. 16.0% The variance or 'riskiness' of the project's expected cashflows (standard deviation squared).
20.0% The annual cash yield lost each year the project is delayed.

OUTPUTS:
d1 -0.6210 The PV of taking on the project now (-50) is less than the option to delay (4), therefore the project should NOT be
N(d1) 0.2673 undertaken now.
d2 -1.5155
There is a 6.5% to 26.7% likelihood that this project will become viable before expiration (as indicated by Nd1 and Nd2).
N(d2) 0.0648

VALUE $3.6 The value of the option to delay New plant.

PARTIALS:
Delta 0.267 Linear exposure to changes in the project cash flows.
Gamma 0.004 Parabolic exposure to changes in the project cash flows.
Theta -3.500 Linear exposure to changes in the project's time to expiration
Vega 73.561 Linear exposure to changes in the project's volatility or 'risk'.
Rho 31.002 Linear exposure to changes in the risk-free rate.
 Highlight a cell labelled "Valuation" to Create or Delete a Binomial branch.

Valuation
Option to Invest
211.8
Underlying Asset
234.0

24891954.xls [Binomial] Page 3 of 8 11/14/2009 08:31:28

 Variables Values Description
K 900.00 Investment required or 'Exercise Price'.
a 2% Annual Growth Rate of Potential Market Cash Flow
q 30% Annual Standard Deviation of Cash Flow in Target Market.
D1 1 Inverse demand function for 1 firm in market.
D2 0.75 Inverse demand function for 2 firms in market.
r 5% Risk-free rate.

Xf 133.86 Level of annual market cash flow for Follower to enter market.

X 120.00 Current expected annual level of cash flow in market.

F(X) 2,106.75 Follower's Payoff Value

L(X) 3,039.42 Value of Leader's future profit flow

L(X) - K 2,139.42 Leader's Payoff Value

S(X) 3,000.00 Value if both firms exercise immediately and Simultaneously.

S(X) - K 2,100.00 Simultaneous Payoff Value

Xl 78.44 Annual market cash flow where value of Leading equals Following.
P(X) P(L) P(F) P(S)
Sensitivity Market Cash Probability for each firm Expected
Table Flow /Yr (X) Exercise Leader Follower Simultaneous Payoff
Expected 120.00 82.87% 14.63% 14.63% 70.75% 2,106.75
41.49 0.00% 0.00% 100.00% 0.00% 492.81
<= Xl
59.96 0.00% 0.00% 100.00% 0.00% 815.61
Xl 78.44 0.00% 0.00% 100.00% 0.00% 1,177.71
96.91 44.75% 35.59% 35.59% 28.83% 1,572.83
Xl < X < Xf
115.39 76.36% 19.12% 19.12% 61.76% 1,996.81
Xf 133.86 100.00% 0.00% 0.00% 100.00% 2,446.61
152.34 100.00% 0.00% 0.00% 100.00% 2,908.49
Xf <= X
170.81 100.00% 0.00% 0.00% 100.00% 3,370.37

Results Summary - for the expected level of annual market cash flows (120.0):

Since the annual expected cash flow (X = 120.0) is between the level of cash flow where the value of Leading equals Following (Xl = 78.4), and the level of cash flow
where the Follower will enter the market (Xf = 133.9), there is an equilibrium set of mixed strategies that each firm will enter the market with probability of 82.9%.

The probability that each firm will enter the market is 82.9%. In equilibrium, each firm has the probability of either Leading or Following of 14.6%, and the remaining
70.7% probability that each firm will enter the market Simultaneously. With respective expected payoff's of: Leading (L(X)-K) = 2139.4; Following F(X) = 2106.8; and
acting Simultaneously (S(X)-K) = 2100.0, the weighted average expected payoff for each firm is 2106.8. Note that the expected payoff from the game, in equilibrium, is
equal to the value of being a Follower.
 Industry/Group Name Average Standard Deviation
54.7%
Advertising
- Advertising 54.7%
53.0%
Aerospace/Defense
- Aerospace/Defense 53.0%
57.4%
Air Transport
- Air Transport 57.4%
48.1%
Apparel
- Apparel 48.1%
43.7%
Auto-&Auto
Truck
& Truck 43.7%
51.8%
Auto-Parts
Auto Parts 51.8%
23.3%
Bank- Bank 23.3%
16.3%
Bank- (Canadian)
Bank (Canadian) 16.3%
33.4%
Bank- (Foreign)
Bank (Foreign) 33.4%
20.4%
Bank- (Midwest)
Bank (Midwest) 20.4%
30.1%
Beverage
- Beverage
(Alcoholic)
(Alcoholic) 30.1%
30.9%
Beverage
- Beverage
(Soft Drink)
(Soft Drink) 30.9%
71.9%
Biotechnology
- Biotechnology 71.9%
46.2%
Building
- Building
Materials
Materials 46.2%
84.0%
Cable- Cable
TV TV 84.0%
26.4%
Canadian
- Canadian
EnergyEnergy 26.4%
32.8%
Cement
- Cement
& Aggregates
& Aggregates 32.8%
37.4%
Chemical
- Chemical
(Basic)(Basic) 37.4%
39.2%
Chemical
- Chemical
(Diversified)
(Diversified) 39.2%
44.1%
Chemical
- Chemical
(Specialty)
(Specialty) 44.1%
45.1%
Coal- Coal 45.1%
77.5%
Computer
- Computer
Software/Svcs
Software/Svcs 77.5%
81.6%
Computers/Peripherals
- Computers/Peripherals 81.6%
37.8%
Diversified
- Diversified
Co. Co. 37.8%
77.1%
Drug- Drug 77.1%
78.1%
E-Commerce
- E-Commerce 78.1%
59.0%
Educational
- Educational
ServicesServices 59.0%
27.2%
Electric
- Electric
Util. (Central)
Util. (Central) 27.2%
22.6%
Electric
- Electric
Utility Utility
(East)(East) 22.6%
28.6%
Electric
- Electric
Utility Utility
(West)(West) 28.6%
60.3%
Electrical
- Electrical
Equipment
Equipment 60.3%
64.1%
Electronics
- Electronics 64.1%
47.7%
Entertainment
- Entertainment 47.7%
66.9%
Entertainment
- Entertainment
Tech Tech 66.9%
61.7%
Environmental
- Environmental 61.7%
45.9%
Financial
- Financial
Svcs. Svcs.
(Div.) (Div.) 45.9%
37.8%
Food- Processing
Food Processing 37.8%
41.0%
Food- Wholesalers
Food Wholesalers 41.0%
29.7%
Foreign
- Foreign
Electronics
Electronics 29.7%
47.9%
Foreign
- Foreign
Telecom.
Telecom. 47.9%
42.3%
Furn/Home
- Furn/Home
Furnishings
Furnishings 42.3%
36.4%
Grocery
- Grocery 36.4%
63.5%
Healthcare
- Healthcare
Information
Information 63.5%
32.7%
Home - Home
Appliance
Appliance 32.7%
34.8%
Homebuilding
- Homebuilding 34.8%
40.4%
Hotel/Gaming
- Hotel/Gaming 40.4%
33.4%
Household
- Household
Products
Products 33.4%
50.9%
Human- Human
Resources
Resources 50.9%
57.8%
Industrial
- Industrial
ServicesServices 57.8%
28.3%
Information
- Information
ServicesServices 28.3%
29.0%
Insurance
- Insurance
(Life) (Life) 29.0%
33.2%
Insurance
- Insurance
(Prop/Cas.)
(Prop/Cas.) 33.2%
95.0%
Internet
- Internet 95.0%
23.5%
Investment
- Investment
Co. Co. 23.5%
26.5%
Investment
- Investment
Co.(Foreign)
Co.(Foreign) 26.5%
46.5%
Machinery
- Machinery 46.5%
55.7%
Manuf.
- Manuf.
Housing/RV
Housing/RV 55.7%
40.4%
Maritime
- Maritime 40.4%
61.0%
Medical
- Medical
ServicesServices 61.0%
58.3%
Medical- Medical
Supplies Supplies 58.3%
46.5%
Metal- Metal
Fabricating
Fabricating 46.5%
55.0%
Metals - Metals
& Mining& Mining
(Div.) (Div.) 55.0%
23.1%
Natural- Natural
Gas (Distrib.)
Gas (Distrib.) 23.1%
42.6%
Natural- Natural
Gas (Div.)
Gas (Div.) 42.6%
22.2%
Newspaper
- Newspaper 22.2%
42.2%
Office - Office
Equip/Supplies
Equip/Supplies 42.2%
41.6%
Oilfield
- Oilfield
Svcs/Equip.
Svcs/Equip. 41.6%
797.0%
Packaging- Packaging
& Container
& Container 797.0%
38.6%
Paper/Forest
- Paper/Forest
Products
Products 38.6%
37.6%
Petroleum
- Petroleum
(Integrated)
(Integrated) 37.6%
47.6%
Petroleum
- Petroleum
(Producing)
(Producing) 47.6%
40.6%
Pharmacy
- Pharmacy
ServicesServices 40.6%
71.1%
Power - Power 71.1%
63.8%
Precious
- Precious
MetalsMetals 63.8%
61.6%
Precision
- Precision
Instrument
Instrument 61.6%
39.7%
Publishing
- Publishing 39.7%
23.3%
R.E.I.T.
- R.E.I.T. 23.3%
27.6%
Railroad
- Railroad 27.6%
51.2%
Recreation
- Recreation 51.2%
41.6%
Restaurant
- Restaurant 41.6%
56.2%
Retail- Retail
(Special(Special
Lines)Lines) 56.2%
39.7%
Retail- Retail
Automotive
Automotive 39.7%
32.0%
Retail- Retail
BuildingBuilding
SupplySupply 32.0%
43.4%
Retail- Retail
Store Store 43.4%
31.0%
Securities
- Securities
Brokerage
Brokerage 31.0%
77.0%
Semiconductor
- Semiconductor 77.0%
66.2%
Semiconductor
- SemiconductorEquip Equip 66.2%
40.8%
Shoe- Shoe 40.8%
46.5%
Steel- (General)
Steel (General) 46.5%
49.6%
Steel- (Integrated)
Steel (Integrated) 49.6%
108.5%
Telecom. - Telecom.
Equipment Equipment 108.5%
74.1%
Telecom.
- Telecom.
ServicesServices 74.1%
23.2%
Thrift- Thrift 23.2%
35.9%
Tire & - Tire
Rubber
& Rubber 35.9%
28.0%
Tobacco- Tobacco 28.0%
47.0%
Toiletries/Cosmetics
- Toiletries/Cosmetics 47.0%
39.6%
Trucking
- Trucking 39.6%
28.5%
Utility- Utility
(Foreign)(Foreign) 28.5%
20.5%
Water - Water
Utility Utility 20.5%
88.9%
Wireless
- Wireless
Networking
Networking 88.9%