A real option adds value to a project, even if it is difficult to determine the monetary amount of that value. If the NPV of the project without the option is positive, the analyst knows that the project with the option must be even more valuable and determining specific calue for the option is unnecessary. Ok I’m cool with that except—don’t you also have to factor in the option cost? Or does the statement above assume that even after subtracting NPV by the option cost you’ll have a positive NPV? For example, NPV = 5. Can you say that any option will add to NPV? No because what if option cost is 8–that would make NPV negative. Q21 on Schweser Exam 3 is like this, but it says that NPV = 3 and option cost = 2.
now that i think about it, i guess it doesnt make sense for option cost to be greater than option value. so option value will always be greater than option cost. so if your npv without options is positive, you should always take the option. if your npv without options is negative, then you need to look at the option value net of cost and if that # added to your negative npv will get you to a positive npv. i guess i answered my own Q.
Not given any information you gotta assume that the real option is costless…it’s more a choice than an option, but technically can be valued like an option.
im not sure you can assume its costless. i figured that the assumption was that if you have a positive npv already, your option cost wont be greater than your option value (otherwise you would never buy the option). so the option value must increase the already positive npv. if npv is negative, the option would increase the npv too. however, the Q is would it increase it enough to make it positive. so for negative npv you have to actually find the option value.
I remember reading somewhere if project is positive, then option must be adding values which means benefit > cost