MayankEmergency. My computer was down all day yesterday and Friday nite. Must have this questioned answered by 8pm tonite. So sorry.Please fill out the answer worksheet tab 12-2 that’s attached12-2 CONCEPTUAL ANALYSIS OF REAL OPTIONS Huntsman Chemical is a relatively smallchemical company located in Port Arthur, Texas. The firm’s management is contemplating its first international investment, which involves the construction of a petrochemicalplant in São Paulo, Brazil. The proposed plant will have the capacity to produce 100,000tons of the plastic pellets that are used to manufacture soft drink bottles. In addition, theplant can be converted over to produce the pellets used in the manufacture of opaqueplastic containers such as milk containers.The initial plant will cost $50 million to build, but its capacity can later be doubledat a cost of $30 million, should the economics warrant it. The plant can be financed witha $40 million nonrecourse loan provided by a consortium of banks and guaranteed bythe Export Import Bank. Huntsman’s management is enthusiastic about the project, asits analysts think that the Brazilian economy is likely to grow into the foreseeable future.This growth, in turn, may offer Huntsman Chemical many additional opportunities inthe future as the company becomes better known in the region.Based on a traditional discounted cash flow analysis, Huntsman’s analysts estimatethat the project has a modest NPV of about $5 million. However, when Huntsman’s executive committee members review the proposal, they express concern about the risk of theventure, based primarily on their view that the Brazilian economy is very uncertain.Towardthe close of their deliberations, the company CEO turns to the senior financial analyst andasks him whether he has considered something the CEO has recently read about called“real options” in performing his discounted cash flow estimate of the project’s NPV.Assume the role of the senior analyst and provide your boss with a brief discussionof the various options that may be embedded in this project, and very roughly sketchout how these options can add to the value of the project. (Hint: No computations arerequired.)Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 475). Prentice Hall. Kindle Edition.PROBLEM 12-1GivenQuantityPrice (Year 0)P-highP-lowForward priceExtraction costsSolution Legend$$$$$10002025152017= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutionYou can lock into the forward rate or sell immediately at thesame spot rate. The payoffs under either action is the same.Selling today is better because of time value of money.Profit (sell today)Cert. Equiv (sell forward)Uncertain ProfitsProfit-highExtract oil only in this state ofthe worldProfit-lowDo not extract oil in this stateof the worldRisk neutral probabilityValue of public landa.b.Equate forward price = expected cash flows based on riskneutral probabilities:20 = 25 * p + 15 * (1 – p). PROBLEM 12-2a.b.c.d.e.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-3GivenSolution LegendVARIATION IN PROBLEM: High price of copperis 2.8 and low price is 1.2= Value given in problemOre purityOre quantity (lbs)Current priceP-highP-lowExpected priceForward priceDevelopment costsAmount payable todayAmount due next yearExtraction costs (per lb of copper)= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output$$$$$$$0.3755,000,0002.202.801.202.502.311,200,000.0075.00%25.00%1.60Cost of capital (exploration)Cost of capital (development)Risk free rate25.00%15.00%5.00%Solutiona. Value of the hedged leaseCertainty Equivalent cash flowsNPVRisk neutral probabilityRisk neutral probabilityb. Value of the undhedged lease without any optionIn the high price scenarioIn the low price stateCertainty equivalentNPVNote: Extraction costs of $1.60 incurred at the beginning of the second year isshifted to the end of the second year by multiplying by the risk free rate. Thismakes all cash flows in the computation consistent (with regard to timing ofcash flows).NPV of project if Newport commits to production today and locks in aforward price.Use forward price to calculate the risk neutralprobability, i.e.,Use todays’ price to calculate the risk neutral probability, i.e.,c, d. Value of the (unhedged) lease with optionIn the high price scenarioIn the low price stateCertainty equivalentNPVCurrentRisk FreeLow1RatePriceRisk Neutral PriceLowProbabilityHighPrice PriceValue of the (unhedged) lease withoutany real optionValue of the (unhedged) lease with realoptione. Strategy of short positions on 1.875m lbs. call options(exercise price = $1.68, maturity = 2, call premium = $0.70/lb)and long position in project.Price = $2.80Price = $1.20Gain/loss on optionsGain/loss on productionNet payoffs at t = 2Payoff from sale of option(at t = 1)Investment in projectNet cash flows at t = 0This strategy resullts in a sureprofit ofFair price of option PROBLEM 12-4: Valuation an American OptionGivenRisk-neutral probabilityRisk free Interest rateDiscount factor = exp(Risk free interest rate)Strike (in $ millions)0.46265%$23.00SolutionTodayYear OneYear TwoYear Three$$Text Color LegendValue of Beginning Oil Field Operations Now $NPV of waiting (NPV-Waiting)NPV of Exercising Now (NPV-Now)Value of American Option = max (NPV-Waiting,NPV-Now)$$14.570031.780028.190025.00019.6600$$26.5500$$35.830023.550020.8800Cell Outline Legend$17.4400StockWaitExercisea.b.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-5GivenPrice of GasSolution Legend$8.00Price of Fuel OilMaxMost likelyMinimumRevenuesWACC$ 12.00$ 2.00$ 10.0010%= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutiona. Estimate the power plant’s cash flowRevenuesLess: Fuel costJet fuel cost (uncertain)Cash flowb.c.$ 10.00$ 7.00 PROBLEM 12-6STATIC ANALYSIS(based on expected prices of gas and Jet fuel)Margin analysis per barrel of crude processedGasolineJet FuelPrice/bbl of output$$Qty of output/bbl of crude0.90.7Revenue/bbl of crude$$Cost/bbl of crude$25.00 $ 25.00Proc cost/bbl of crude$$Gross Profit/bbl of crude$(25.00) $ (25.00)GivenCost of building the refinery$2,000,000,000Refinery life5 yearsDepreciation = straight line with no salvage valueGasoline prices (next year)Maximum$Most likely$Minimum$Expected price$Jet fuel prices (next year)$$$$Refining capacityCrude oil in bblsConversion to gasolineConversion to jet fuelCost of purchasing crude/bbl$Other costs of refiningCost of capitalTax rateRiskfree rate4.002.501.75-MaximumMost likelyMinimumExpected price5.003.252.5012,000,00090%70%25.0035% price of fuel10%30%5.5%1Price of gasolinePrice of jet fuelRevenuesGasolineJet fuelRevenues for Output ChoiceLess: Cost of purchasing crudeLess: Cost of refiningLess: DepreciationEBITLess: TaxesNOPATPlus: DepreciationCash flowa. NPVSwitch to jet fuelb.This implies that jet fuel is preferable (provides highermargins)Revenures (Jet Fuel)$Cost of purchasing crude$(300,000,000)Cost of refining$Depreciation$(400,000,000)EBIT$(700,000,000)Less: Taxes$210,000,000NOPAT$(490,000,000)Depreciation$400,000,000Project FCF$(90,000,000)NPV$(2,341,170,809)2Year345Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputNegative NPV based onexpected prices of jet fuel PROBLEM 12-7Do nothingProperty 1UnitsRent/month$Yearly revenuesPotential valueSolution Legend42,000= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputProperty 2UnitsRent/monthYearly revenuesPotential value4$1,500New constructionUnits10Rent/month$2,500Yearly revenuesValueCost$1,500,000NPVAssume: risk free rate of 5%and volatility of 20%r0.05T1sigma0.2X1500000Underlying3000000d1N(d1)d2N(d2)BasicCallvalue to calculate NPVProperty 1 NPVProperty 2 calla.b.c.Property 2 has a greater NPVbecause forgeone value is less. PROBLEM 12-8GivenRisk free rateDividend yieldExercise price (I)Current value (V)VolatilityVolatility ^2NPV$$$5%10%50,000,00045,000,00020%0.0400(5,000,000)The right to develop the casino can be thought of as a American Call Option with infinite life.Immediate exercise of this option results in a negative NPV (-50 m + 45 m = -5 million). However,the real estate development option has a value of $3.317 million because of the inherentuncertainty in the prospects of the casino industry in that region. This uncertainty suggest that itmay be worth waiting.SolutionCall Option ValueV*Call (Infinite life option)NPV*Casino Development Option ValueCritical ValueCritical NPV valueSolution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output
MayankEmergency. My computer was down all day yesterday and Friday nite. Must have this questioned answered by 8pm tonite. So sorry.Please fill out the answer worksheet tab 12-2 that’s attached12-2 CONCEPTUAL ANALYSIS OF REAL OPTIONS Huntsman Chemical is a relatively smallchemical company located in Port Arthur, Texas. The firm’s management is contemplating its first international investment, which involves the construction of a petrochemicalplant in São Paulo, Brazil. The proposed plant will have the capacity to produce 100,000tons of the plastic pellets that are used to manufacture soft drink bottles. In addition, theplant can be converted over to produce the pellets used in the manufacture of opaqueplastic containers such as milk containers.The initial plant will cost $50 million to build, but its capacity can later be doubledat a cost of $30 million, should the economics warrant it. The plant can be financed witha $40 million nonrecourse loan provided by a consortium of banks and guaranteed bythe Export Import Bank. Huntsman’s management is enthusiastic about the project, asits analysts think that the Brazilian economy is likely to grow into the foreseeable future.This growth, in turn, may offer Huntsman Chemical many additional opportunities inthe future as the company becomes better known in the region.Based on a traditional discounted cash flow analysis, Huntsman’s analysts estimatethat the project has a modest NPV of about $5 million. However, when Huntsman’s executive committee members review the proposal, they express concern about the risk of theventure, based primarily on their view that the Brazilian economy is very uncertain.Towardthe close of their deliberations, the company CEO turns to the senior financial analyst andasks him whether he has considered something the CEO has recently read about called“real options” in performing his discounted cash flow estimate of the project’s NPV.Assume the role of the senior analyst and provide your boss with a brief discussionof the various options that may be embedded in this project, and very roughly sketchout how these options can add to the value of the project. (Hint: No computations arerequired.)Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 475). Prentice Hall. Kindle Edition.PROBLEM 12-1GivenQuantityPrice (Year 0)P-highP-lowForward priceExtraction costsSolution Legend$$$$$10002025152017= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutionYou can lock into the forward rate or sell immediately at thesame spot rate. The payoffs under either action is the same.Selling today is better because of time value of money.Profit (sell today)Cert. Equiv (sell forward)Uncertain ProfitsProfit-highExtract oil only in this state ofthe worldProfit-lowDo not extract oil in this stateof the worldRisk neutral probabilityValue of public landa.b.Equate forward price = expected cash flows based on riskneutral probabilities:20 = 25 * p + 15 * (1 – p). PROBLEM 12-2a.b.c.d.e.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-3GivenSolution LegendVARIATION IN PROBLEM: High price of copperis 2.8 and low price is 1.2= Value given in problemOre purityOre quantity (lbs)Current priceP-highP-lowExpected priceForward priceDevelopment costsAmount payable todayAmount due next yearExtraction costs (per lb of copper)= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output$$$$$$$0.3755,000,0002.202.801.202.502.311,200,000.0075.00%25.00%1.60Cost of capital (exploration)Cost of capital (development)Risk free rate25.00%15.00%5.00%Solutiona. Value of the hedged leaseCertainty Equivalent cash flowsNPVRisk neutral probabilityRisk neutral probabilityb. Value of the undhedged lease without any optionIn the high price scenarioIn the low price stateCertainty equivalentNPVNote: Extraction costs of $1.60 incurred at the beginning of the second year isshifted to the end of the second year by multiplying by the risk free rate. Thismakes all cash flows in the computation consistent (with regard to timing ofcash flows).NPV of project if Newport commits to production today and locks in aforward price.Use forward price to calculate the risk neutralprobability, i.e.,Use todays’ price to calculate the risk neutral probability, i.e.,c, d. Value of the (unhedged) lease with optionIn the high price scenarioIn the low price stateCertainty equivalentNPVCurrentRisk FreeLow1RatePriceRisk Neutral PriceLowProbabilityHighPrice PriceValue of the (unhedged) lease withoutany real optionValue of the (unhedged) lease with realoptione. Strategy of short positions on 1.875m lbs. call options(exercise price = $1.68, maturity = 2, call premium = $0.70/lb)and long position in project.Price = $2.80Price = $1.20Gain/loss on optionsGain/loss on productionNet payoffs at t = 2Payoff from sale of option(at t = 1)Investment in projectNet cash flows at t = 0This strategy resullts in a sureprofit ofFair price of option PROBLEM 12-4: Valuation an American OptionGivenRisk-neutral probabilityRisk free Interest rateDiscount factor = exp(Risk free interest rate)Strike (in $ millions)0.46265%$23.00SolutionTodayYear OneYear TwoYear Three$$Text Color LegendValue of Beginning Oil Field Operations Now $NPV of waiting (NPV-Waiting)NPV of Exercising Now (NPV-Now)Value of American Option = max (NPV-Waiting,NPV-Now)$$14.570031.780028.190025.00019.6600$$26.5500$$35.830023.550020.8800Cell Outline Legend$17.4400StockWaitExercisea.b.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-5GivenPrice of GasSolution Legend$8.00Price of Fuel OilMaxMost likelyMinimumRevenuesWACC$ 12.00$ 2.00$ 10.0010%= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutiona. Estimate the power plant’s cash flowRevenuesLess: Fuel costJet fuel cost (uncertain)Cash flowb.c.$ 10.00$ 7.00 PROBLEM 12-6STATIC ANALYSIS(based on expected prices of gas and Jet fuel)Margin analysis per barrel of crude processedGasolineJet FuelPrice/bbl of output$$Qty of output/bbl of crude0.90.7Revenue/bbl of crude$$Cost/bbl of crude$25.00 $ 25.00Proc cost/bbl of crude$$Gross Profit/bbl of crude$(25.00) $ (25.00)GivenCost of building the refinery$2,000,000,000Refinery life5 yearsDepreciation = straight line with no salvage valueGasoline prices (next year)Maximum$Most likely$Minimum$Expected price$Jet fuel prices (next year)$$$$Refining capacityCrude oil in bblsConversion to gasolineConversion to jet fuelCost of purchasing crude/bbl$Other costs of refiningCost of capitalTax rateRiskfree rate4.002.501.75-MaximumMost likelyMinimumExpected price5.003.252.5012,000,00090%70%25.0035% price of fuel10%30%5.5%1Price of gasolinePrice of jet fuelRevenuesGasolineJet fuelRevenues for Output ChoiceLess: Cost of purchasing crudeLess: Cost of refiningLess: DepreciationEBITLess: TaxesNOPATPlus: DepreciationCash flowa. NPVSwitch to jet fuelb.This implies that jet fuel is preferable (provides highermargins)Revenures (Jet Fuel)$Cost of purchasing crude$(300,000,000)Cost of refining$Depreciation$(400,000,000)EBIT$(700,000,000)Less: Taxes$210,000,000NOPAT$(490,000,000)Depreciation$400,000,000Project FCF$(90,000,000)NPV$(2,341,170,809)2Year345Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputNegative NPV based onexpected prices of jet fuel PROBLEM 12-7Do nothingProperty 1UnitsRent/month$Yearly revenuesPotential valueSolution Legend42,000= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputProperty 2UnitsRent/monthYearly revenuesPotential value4$1,500New constructionUnits10Rent/month$2,500Yearly revenuesValueCost$1,500,000NPVAssume: risk free rate of 5%and volatility of 20%r0.05T1sigma0.2X1500000Underlying3000000d1N(d1)d2N(d2)BasicCallvalue to calculate NPVProperty 1 NPVProperty 2 calla.b.c.Property 2 has a greater NPVbecause forgeone value is less. PROBLEM 12-8GivenRisk free rateDividend yieldExercise price (I)Current value (V)VolatilityVolatility ^2NPV$$$5%10%50,000,00045,000,00020%0.0400(5,000,000)The right to develop the casino can be thought of as a American Call Option with infinite life.Immediate exercise of this option results in a negative NPV (-50 m + 45 m = -5 million). However,the real estate development option has a value of $3.317 million because of the inherentuncertainty in the prospects of the casino industry in that region. This uncertainty suggest that itmay be worth waiting.SolutionCall Option ValueV*Call (Infinite life option)NPV*Casino Development Option ValueCritical ValueCritical NPV valueSolution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output
MayankEmergency. My computer was down all day yesterday and Friday nite. Must have this questioned answered by 8pm tonite. So sorry.Please fill out the answer worksheet tab 12-2 that’s attached12-2 CONCEPTUAL ANALYSIS OF REAL OPTIONS Huntsman Chemical is a relatively smallchemical company located in Port Arthur, Texas. The firm’s management is contemplating its first international investment, which involves the construction of a petrochemicalplant in São Paulo, Brazil. The proposed plant will have the capacity to produce 100,000tons of the plastic pellets that are used to manufacture soft drink bottles. In addition, theplant can be converted over to produce the pellets used in the manufacture of opaqueplastic containers such as milk containers.The initial plant will cost $50 million to build, but its capacity can later be doubledat a cost of $30 million, should the economics warrant it. The plant can be financed witha $40 million nonrecourse loan provided by a consortium of banks and guaranteed bythe Export Import Bank. Huntsman’s management is enthusiastic about the project, asits analysts think that the Brazilian economy is likely to grow into the foreseeable future.This growth, in turn, may offer Huntsman Chemical many additional opportunities inthe future as the company becomes better known in the region.Based on a traditional discounted cash flow analysis, Huntsman’s analysts estimatethat the project has a modest NPV of about $5 million. However, when Huntsman’s executive committee members review the proposal, they express concern about the risk of theventure, based primarily on their view that the Brazilian economy is very uncertain.Towardthe close of their deliberations, the company CEO turns to the senior financial analyst andasks him whether he has considered something the CEO has recently read about called“real options” in performing his discounted cash flow estimate of the project’s NPV.Assume the role of the senior analyst and provide your boss with a brief discussionof the various options that may be embedded in this project, and very roughly sketchout how these options can add to the value of the project. (Hint: No computations arerequired.)Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 475). Prentice Hall. Kindle Edition.PROBLEM 12-1GivenQuantityPrice (Year 0)P-highP-lowForward priceExtraction costsSolution Legend$$$$$10002025152017= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutionYou can lock into the forward rate or sell immediately at thesame spot rate. The payoffs under either action is the same.Selling today is better because of time value of money.Profit (sell today)Cert. Equiv (sell forward)Uncertain ProfitsProfit-highExtract oil only in this state ofthe worldProfit-lowDo not extract oil in this stateof the worldRisk neutral probabilityValue of public landa.b.Equate forward price = expected cash flows based on riskneutral probabilities:20 = 25 * p + 15 * (1 – p). PROBLEM 12-2a.b.c.d.e.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-3GivenSolution LegendVARIATION IN PROBLEM: High price of copperis 2.8 and low price is 1.2= Value given in problemOre purityOre quantity (lbs)Current priceP-highP-lowExpected priceForward priceDevelopment costsAmount payable todayAmount due next yearExtraction costs (per lb of copper)= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output$$$$$$$0.3755,000,0002.202.801.202.502.311,200,000.0075.00%25.00%1.60Cost of capital (exploration)Cost of capital (development)Risk free rate25.00%15.00%5.00%Solutiona. Value of the hedged leaseCertainty Equivalent cash flowsNPVRisk neutral probabilityRisk neutral probabilityb. Value of the undhedged lease without any optionIn the high price scenarioIn the low price stateCertainty equivalentNPVNote: Extraction costs of $1.60 incurred at the beginning of the second year isshifted to the end of the second year by multiplying by the risk free rate. Thismakes all cash flows in the computation consistent (with regard to timing ofcash flows).NPV of project if Newport commits to production today and locks in aforward price.Use forward price to calculate the risk neutralprobability, i.e.,Use todays’ price to calculate the risk neutral probability, i.e.,c, d. Value of the (unhedged) lease with optionIn the high price scenarioIn the low price stateCertainty equivalentNPVCurrentRisk FreeLow1RatePriceRisk Neutral PriceLowProbabilityHighPrice PriceValue of the (unhedged) lease withoutany real optionValue of the (unhedged) lease with realoptione. Strategy of short positions on 1.875m lbs. call options(exercise price = $1.68, maturity = 2, call premium = $0.70/lb)and long position in project.Price = $2.80Price = $1.20Gain/loss on optionsGain/loss on productionNet payoffs at t = 2Payoff from sale of option(at t = 1)Investment in projectNet cash flows at t = 0This strategy resullts in a sureprofit ofFair price of option PROBLEM 12-4: Valuation an American OptionGivenRisk-neutral probabilityRisk free Interest rateDiscount factor = exp(Risk free interest rate)Strike (in $ millions)0.46265%$23.00SolutionTodayYear OneYear TwoYear Three$$Text Color LegendValue of Beginning Oil Field Operations Now $NPV of waiting (NPV-Waiting)NPV of Exercising Now (NPV-Now)Value of American Option = max (NPV-Waiting,NPV-Now)$$14.570031.780028.190025.00019.6600$$26.5500$$35.830023.550020.8800Cell Outline Legend$17.4400StockWaitExercisea.b.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-5GivenPrice of GasSolution Legend$8.00Price of Fuel OilMaxMost likelyMinimumRevenuesWACC$ 12.00$ 2.00$ 10.0010%= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutiona. Estimate the power plant’s cash flowRevenuesLess: Fuel costJet fuel cost (uncertain)Cash flowb.c.$ 10.00$ 7.00 PROBLEM 12-6STATIC ANALYSIS(based on expected prices of gas and Jet fuel)Margin analysis per barrel of crude processedGasolineJet FuelPrice/bbl of output$$Qty of output/bbl of crude0.90.7Revenue/bbl of crude$$Cost/bbl of crude$25.00 $ 25.00Proc cost/bbl of crude$$Gross Profit/bbl of crude$(25.00) $ (25.00)GivenCost of building the refinery$2,000,000,000Refinery life5 yearsDepreciation = straight line with no salvage valueGasoline prices (next year)Maximum$Most likely$Minimum$Expected price$Jet fuel prices (next year)$$$$Refining capacityCrude oil in bblsConversion to gasolineConversion to jet fuelCost of purchasing crude/bbl$Other costs of refiningCost of capitalTax rateRiskfree rate4.002.501.75-MaximumMost likelyMinimumExpected price5.003.252.5012,000,00090%70%25.0035% price of fuel10%30%5.5%1Price of gasolinePrice of jet fuelRevenuesGasolineJet fuelRevenues for Output ChoiceLess: Cost of purchasing crudeLess: Cost of refiningLess: DepreciationEBITLess: TaxesNOPATPlus: DepreciationCash flowa. NPVSwitch to jet fuelb.This implies that jet fuel is preferable (provides highermargins)Revenures (Jet Fuel)$Cost of purchasing crude$(300,000,000)Cost of refining$Depreciation$(400,000,000)EBIT$(700,000,000)Less: Taxes$210,000,000NOPAT$(490,000,000)Depreciation$400,000,000Project FCF$(90,000,000)NPV$(2,341,170,809)2Year345Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputNegative NPV based onexpected prices of jet fuel PROBLEM 12-7Do nothingProperty 1UnitsRent/month$Yearly revenuesPotential valueSolution Legend42,000= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputProperty 2UnitsRent/monthYearly revenuesPotential value4$1,500New constructionUnits10Rent/month$2,500Yearly revenuesValueCost$1,500,000NPVAssume: risk free rate of 5%and volatility of 20%r0.05T1sigma0.2X1500000Underlying3000000d1N(d1)d2N(d2)BasicCallvalue to calculate NPVProperty 1 NPVProperty 2 calla.b.c.Property 2 has a greater NPVbecause forgeone value is less. PROBLEM 12-8GivenRisk free rateDividend yieldExercise price (I)Current value (V)VolatilityVolatility ^2NPV$$$5%10%50,000,00045,000,00020%0.0400(5,000,000)The right to develop the casino can be thought of as a American Call Option with infinite life.Immediate exercise of this option results in a negative NPV (-50 m + 45 m = -5 million). However,the real estate development option has a value of $3.317 million because of the inherentuncertainty in the prospects of the casino industry in that region. This uncertainty suggest that itmay be worth waiting.SolutionCall Option ValueV*Call (Infinite life option)NPV*Casino Development Option ValueCritical ValueCritical NPV valueSolution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output
MayankEmergency. My computer was down all day yesterday and Friday nite. Must have this questioned answered by 8pm tonite. So sorry.Please fill out the answer worksheet tab 12-2 that’s attached12-2 CONCEPTUAL ANALYSIS OF REAL OPTIONS Huntsman Chemical is a relatively smallchemical company located in Port Arthur, Texas. The firm’s management is contemplating its first international investment, which involves the construction of a petrochemicalplant in São Paulo, Brazil. The proposed plant will have the capacity to produce 100,000tons of the plastic pellets that are used to manufacture soft drink bottles. In addition, theplant can be converted over to produce the pellets used in the manufacture of opaqueplastic containers such as milk containers.The initial plant will cost $50 million to build, but its capacity can later be doubledat a cost of $30 million, should the economics warrant it. The plant can be financed witha $40 million nonrecourse loan provided by a consortium of banks and guaranteed bythe Export Import Bank. Huntsman’s management is enthusiastic about the project, asits analysts think that the Brazilian economy is likely to grow into the foreseeable future.This growth, in turn, may offer Huntsman Chemical many additional opportunities inthe future as the company becomes better known in the region.Based on a traditional discounted cash flow analysis, Huntsman’s analysts estimatethat the project has a modest NPV of about $5 million. However, when Huntsman’s executive committee members review the proposal, they express concern about the risk of theventure, based primarily on their view that the Brazilian economy is very uncertain.Towardthe close of their deliberations, the company CEO turns to the senior financial analyst andasks him whether he has considered something the CEO has recently read about called“real options” in performing his discounted cash flow estimate of the project’s NPV.Assume the role of the senior analyst and provide your boss with a brief discussionof the various options that may be embedded in this project, and very roughly sketchout how these options can add to the value of the project. (Hint: No computations arerequired.)Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 475). Prentice Hall. Kindle Edition.PROBLEM 12-1GivenQuantityPrice (Year 0)P-highP-lowForward priceExtraction costsSolution Legend$$$$$10002025152017= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutionYou can lock into the forward rate or sell immediately at thesame spot rate. The payoffs under either action is the same.Selling today is better because of time value of money.Profit (sell today)Cert. Equiv (sell forward)Uncertain ProfitsProfit-highExtract oil only in this state ofthe worldProfit-lowDo not extract oil in this stateof the worldRisk neutral probabilityValue of public landa.b.Equate forward price = expected cash flows based on riskneutral probabilities:20 = 25 * p + 15 * (1 – p). PROBLEM 12-2a.b.c.d.e.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-3GivenSolution LegendVARIATION IN PROBLEM: High price of copperis 2.8 and low price is 1.2= Value given in problemOre purityOre quantity (lbs)Current priceP-highP-lowExpected priceForward priceDevelopment costsAmount payable todayAmount due next yearExtraction costs (per lb of copper)= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output$$$$$$$0.3755,000,0002.202.801.202.502.311,200,000.0075.00%25.00%1.60Cost of capital (exploration)Cost of capital (development)Risk free rate25.00%15.00%5.00%Solutiona. Value of the hedged leaseCertainty Equivalent cash flowsNPVRisk neutral probabilityRisk neutral probabilityb. Value of the undhedged lease without any optionIn the high price scenarioIn the low price stateCertainty equivalentNPVNote: Extraction costs of $1.60 incurred at the beginning of the second year isshifted to the end of the second year by multiplying by the risk free rate. Thismakes all cash flows in the computation consistent (with regard to timing ofcash flows).NPV of project if Newport commits to production today and locks in aforward price.Use forward price to calculate the risk neutralprobability, i.e.,Use todays’ price to calculate the risk neutral probability, i.e.,c, d. Value of the (unhedged) lease with optionIn the high price scenarioIn the low price stateCertainty equivalentNPVCurrentRisk FreeLow1RatePriceRisk Neutral PriceLowProbabilityHighPrice PriceValue of the (unhedged) lease withoutany real optionValue of the (unhedged) lease with realoptione. Strategy of short positions on 1.875m lbs. call options(exercise price = $1.68, maturity = 2, call premium = $0.70/lb)and long position in project.Price = $2.80Price = $1.20Gain/loss on optionsGain/loss on productionNet payoffs at t = 2Payoff from sale of option(at t = 1)Investment in projectNet cash flows at t = 0This strategy resullts in a sureprofit ofFair price of option PROBLEM 12-4: Valuation an American OptionGivenRisk-neutral probabilityRisk free Interest rateDiscount factor = exp(Risk free interest rate)Strike (in $ millions)0.46265%$23.00SolutionTodayYear OneYear TwoYear Three$$Text Color LegendValue of Beginning Oil Field Operations Now $NPV of waiting (NPV-Waiting)NPV of Exercising Now (NPV-Now)Value of American Option = max (NPV-Waiting,NPV-Now)$$14.570031.780028.190025.00019.6600$$26.5500$$35.830023.550020.8800Cell Outline Legend$17.4400StockWaitExercisea.b.Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output PROBLEM 12-5GivenPrice of GasSolution Legend$8.00Price of Fuel OilMaxMost likelyMinimumRevenuesWACC$ 12.00$ 2.00$ 10.0010%= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputSolutiona. Estimate the power plant’s cash flowRevenuesLess: Fuel costJet fuel cost (uncertain)Cash flowb.c.$ 10.00$ 7.00 PROBLEM 12-6STATIC ANALYSIS(based on expected prices of gas and Jet fuel)Margin analysis per barrel of crude processedGasolineJet FuelPrice/bbl of output$$Qty of output/bbl of crude0.90.7Revenue/bbl of crude$$Cost/bbl of crude$25.00 $ 25.00Proc cost/bbl of crude$$Gross Profit/bbl of crude$(25.00) $ (25.00)GivenCost of building the refinery$2,000,000,000Refinery life5 yearsDepreciation = straight line with no salvage valueGasoline prices (next year)Maximum$Most likely$Minimum$Expected price$Jet fuel prices (next year)$$$$Refining capacityCrude oil in bblsConversion to gasolineConversion to jet fuelCost of purchasing crude/bbl$Other costs of refiningCost of capitalTax rateRiskfree rate4.002.501.75-MaximumMost likelyMinimumExpected price5.003.252.5012,000,00090%70%25.0035% price of fuel10%30%5.5%1Price of gasolinePrice of jet fuelRevenuesGasolineJet fuelRevenues for Output ChoiceLess: Cost of purchasing crudeLess: Cost of refiningLess: DepreciationEBITLess: TaxesNOPATPlus: DepreciationCash flowa. NPVSwitch to jet fuelb.This implies that jet fuel is preferable (provides highermargins)Revenures (Jet Fuel)$Cost of purchasing crude$(300,000,000)Cost of refining$Depreciation$(400,000,000)EBIT$(700,000,000)Less: Taxes$210,000,000NOPAT$(490,000,000)Depreciation$400,000,000Project FCF$(90,000,000)NPV$(2,341,170,809)2Year345Solution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputNegative NPV based onexpected prices of jet fuel PROBLEM 12-7Do nothingProperty 1UnitsRent/month$Yearly revenuesPotential valueSolution Legend42,000= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball OutputProperty 2UnitsRent/monthYearly revenuesPotential value4$1,500New constructionUnits10Rent/month$2,500Yearly revenuesValueCost$1,500,000NPVAssume: risk free rate of 5%and volatility of 20%r0.05T1sigma0.2X1500000Underlying3000000d1N(d1)d2N(d2)BasicCallvalue to calculate NPVProperty 1 NPVProperty 2 calla.b.c.Property 2 has a greater NPVbecause forgeone value is less. PROBLEM 12-8GivenRisk free rateDividend yieldExercise price (I)Current value (V)VolatilityVolatility ^2NPV$$$5%10%50,000,00045,000,00020%0.0400(5,000,000)The right to develop the casino can be thought of as a American Call Option with infinite life.Immediate exercise of this option results in a negative NPV (-50 m + 45 m = -5 million). However,the real estate development option has a value of $3.317 million because of the inherentuncertainty in the prospects of the casino industry in that region. This uncertainty suggest that itmay be worth waiting.SolutionCall Option ValueV*Call (Infinite life option)NPV*Casino Development Option ValueCritical ValueCritical NPV valueSolution Legend= Value given in problem= Formula/Calculation/Analysis required= Qualitative analysis or Short answer required= Goal Seek or Solver cell= Crystal Ball Input= Crystal Ball Output
