Real Options Exercises

Harvard Business School Case 9-208-045

Courseware 9-208-703

This courseware was prepared solely as the basis for class discussion. Cases are not intended to
serve as endorsements, sources of primary data, or illustrations of effective or ineffective
management. Copyright © 2007 President and Fellows of Harvard College. No part of this product
may be reproduced, stored in a retrieval system, used in a spreadsheet or transmitted in any form or
by any means—electronic, mechanical, photocopying, recording or otherwise—without the
permission of Harvard Business School.
Real Options Exercises
Problem 2

Table A
Round 1
Year 0 1 2 3 4 5 6 7 8 9
After-tax cash flow 10.0 12.0 15.0 15.5 15.9 16.4 16.9 17.4 17.9
Investment -145.0
Net cash flow -145.0 10.0 12.0 15.0 15.5 15.9 16.4 16.9 17.4 17.9

Round 2
Year 0 1 2 3 4 5 6 7 8 9
After-tax cash flow 20.0 24.0 30.0 30.9 31.8 32.8
Investment -250.0
Net cash flow 0 0 0 -250.0 20.0 24.0 30.0 30.9 31.8 32.8

Round 3
Year 0 1 2 3 4 5 6 7 8 9
After-tax cash flow 40.0 48.0 60.0
Investment -450.0
Net cash flow 0 0 0 0 0 0 -450.0 40.0 48.0 60.0

Table B
Rounds 1-3
Year 0 1 2 3 4 5 6 7 8 9
After-tax cash flow 0.0 10.0 12.0 15.0 35.5 39.9 46.4 87.8 97.2 110.7
Investment -145.0 -250.0 -450.0
Net cash flow -145.0 10.0 12.0 -235.0 35.5 39.9 -403.6 87.8 97.2 110.7
 Black-Scholes-Merton Value of a European Call Option, Expressed as a Percentage of Underlying Asset Value
NPVq = (Underlying asset value) / PV(Exercise price)

0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.82 0.84 0.86 0.88 0.90 0.92 0.94 0.96 0.98 1.00 1.02 1.04 1.06 1.08 1.10 1.12 1.14 1.16 1.18 1.20 1.25 1.30 1.35 1.40 1.45 1.50 1.75 2.00 2.50
0.05 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.3 0.6 1.2 2.0 3.1 4.5 6.0 7.5 9.1 10.7 12.3 13.8 15.3 16.7 20.0 23.1 25.9 28.6 31.0 33.3 42.9 50.0 60.0 0.05
0.10 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.2 0.3 0.5 0.8 1.2 1.7 2.3 3.1 4.0 5.0 6.1 7.3 8.6 10.0 11.3 12.7 14.1 15.4 16.8 20.0 23.1 25.9 28.6 31.0 33.3 42.9 50.0 60.0 0.10
0.15 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.2 0.5 0.7 1.0 1.3 1.7 2.2 2.8 3.5 4.2 5.1 6.0 7.0 8.0 9.1 10.2 11.4 12.6 13.8 15.0 16.2 17.4 20.4 23.3 26.0 28.6 31.1 33.3 42.9 50.0 60.0 0.15
0.20 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.4 0.8 1.5 1.9 2.3 2.8 3.4 4.0 4.7 5.4 6.2 7.1 8.0 8.9 9.9 10.9 11.9 13.0 14.1 15.2 16.3 17.4 18.5 21.2 23.9 26.4 28.9 31.2 33.5 42.9 50.0 60.0 0.20
0.25 0.0 0.0 0.0 0.0 0.0 0.1 0.2 0.5 1.0 1.8 2.8 3.3 3.9 4.5 5.2 5.9 6.6 7.4 8.2 9.1 9.9 10.9 11.8 12.8 13.7 14.7 15.7 16.7 17.7 18.7 19.8 22.3 24.7 27.1 29.4 31.7 33.8 42.9 50.0 60.0 0.25
0.30 0.0 0.0 0.0 0.1 0.1 0.3 0.7 1.2 2.0 3.1 4.4 5.0 5.7 6.3 7.0 7.8 8.6 9.4 10.2 11.1 11.9 12.8 13.7 14.6 15.6 16.5 17.4 18.4 19.3 20.3 21.2 23.5 25.8 28.1 30.2 32.3 34.3 43.1 50.1 60.0 0.30
0.35 0.0 0.0 0.1 0.2 0.4 0.8 1.4 2.3 3.3 4.6 6.2 6.8 7.5 8.2 9.0 9.8 10.6 11.4 12.2 13.0 13.9 14.8 15.6 16.5 17.4 18.3 19.2 20.1 21.0 21.9 22.7 24.9 27.1 29.2 31.2 33.2 35.1 43.5 50.2 60.0 0.35
0.40 0.0 0.1 0.2 0.5 0.9 1.6 2.4 3.5 4.8 6.3 8.0 8.7 9.4 10.2 11.0 11.7 12.5 13.4 14.2 15.0 15.9 16.7 17.5 18.4 19.2 20.1 20.9 21.8 22.6 23.5 24.3 26.4 28.4 30.4 32.3 34.2 36.0 44.0 50.5 60.1 0.40
0.45 0.1 0.2 0.5 1.0 1.7 2.6 3.7 5.0 6.5 8.1 9.9 10.6 11.4 12.2 12.9 13.7 14.5 15.3 16.2 17.0 17.8 18.6 19.4 20.3 21.1 21.9 22.7 23.5 24.3 25.1 25.9 27.9 29.8 31.7 33.5 35.3 37.0 44.6 50.8 60.2 0.45
0.50 0.2 0.5 1.0 1.7 2.6 3.7 5.1 6.6 8.2 10.0 11.8 12.6 13.4 14.2 14.9 15.7 16.5 17.3 18.1 18.9 19.7 20.5 21.3 22.1 22.9 23.7 24.5 25.3 26.1 26.8 27.6 29.5 31.3 33.1 34.8 36.4 38.1 45.3 51.3 60.4 0.50
0.55 0.5 1.0 1.7 2.6 3.8 5.1 6.6 8.3 10.0 11.9 13.8 14.6 15.4 16.1 16.9 17.7 18.5 19.3 20.1 20.9 21.7 22.4 23.2 24.0 24.8 25.5 26.3 27.0 27.8 28.5 29.2 31.0 32.8 34.5 36.1 37.7 39.2 46.1 51.9 60.7 0.55
0.60 0.9 1.6 2.5 3.7 5.1 6.6 8.3 10.1 11.9 13.8 15.8 16.6 17.4 18.1 18.9 19.7 20.5 21.3 22.0 22.8 23.6 24.3 25.1 25.8 26.6 27.3 28.1 28.8 29.5 30.2 30.9 32.6 34.3 35.9 37.5 39.0 40.4 47.0 52.5 61.0 0.60
0.65 1.4 2.4 3.6 4.9 6.5 8.2 10.0 11.9 13.8 15.8 17.8 18.6 19.3 20.1 20.9 21.7 22.5 23.2 24.0 24.7 25.5 26.2 27.0 27.7 28.4 29.1 29.8 30.5 31.2 31.9 32.6 34.2 35.8 37.4 38.9 40.3 41.7 48.0 53.3 61.4 0.65
0.70 2.1 3.3 4.7 6.3 8.1 9.9 11.9 13.8 15.8 17.8 19.8 20.6 21.3 22.1 22.9 23.6 24.4 25.2 25.9 26.6 27.4 28.1 28.8 29.5 30.2 30.9 31.6 32.3 32.9 33.6 34.2 35.8 37.3 38.8 40.3 41.6 43.0 49.0 54.0 61.9 0.70
0.75 3.0 4.4 6.1 7.9 9.8 11.7 13.7 15.8 17.8 19.8 21.8 22.5 23.3 24.1 24.8 25.6 26.3 27.1 27.8 28.5 29.2 29.9 30.6 31.3 32.0 32.7 33.3 34.0 34.6 35.3 35.9 37.4 38.9 40.3 41.7 43.0 44.3 50.0 54.9 62.4 0.75
0.80 4.0 5.7 7.5 9.5 11.5 13.6 15.7 17.7 19.8 21.8 23.7 24.5 25.3 26.0 26.8 27.5 28.3 29.0 29.7 30.4 31.1 31.8 32.4 33.1 33.8 34.4 35.1 35.7 36.3 36.9 37.5 39.0 40.4 41.8 43.1 44.4 45.6 51.1 55.8 63.0 0.80
0.85 5.1 7.1 9.1 11.2 13.3 15.5 17.6 19.7 21.8 23.8 25.7 26.5 27.2 28.0 28.7 29.4 30.2 30.9 31.6 32.2 32.9 33.6 34.2 34.9 35.5 36.2 36.8 37.4 38.0 38.6 39.2 40.6 41.9 43.3 44.5 45.8 46.9 52.2 56.7 63.6 0.85
0.90 6.4 8.5 10.7 13.0 15.2 17.4 19.6 21.7 23.8 25.8 27.7 28.4 29.2 29.9 30.6 31.3 32.0 32.7 33.4 34.1 34.7 35.4 36.0 36.6 37.3 37.9 38.5 39.1 39.6 40.2 40.8 42.1 43.5 44.7 46.0 47.1 48.3 53.3 57.6 64.3 0.90
Cumulative Volatility s√t

0.95 7.8 10.1 12.5 14.8 17.1 19.4 21.6 23.7 25.7 27.7 29.6 30.4 31.1 31.8 32.5 33.2 33.9 34.6 35.2 35.9 36.5 37.2 37.8 38.4 39.0 39.6 40.1 40.7 41.3 41.8 42.4 43.7 45.0 46.2 47.4 48.5 49.6 54.5 58.6 65.0 0.95
1.00 9.3 11.8 14.3 16.7 19.1 21.4 23.6 25.7 27.7 29.7 31.6 32.3 33.0 33.7 34.4 35.1 35.7 36.4 37.0 37.7 38.3 38.9 39.5 40.1 40.7 41.2 41.8 42.4 42.9 43.4 44.0 45.2 46.5 47.6 48.8 49.9 50.9 55.6 59.5 65.7 1.00
1.05 10.9 13.6 16.1 18.6 21.0 23.3 25.6 27.7 29.7 31.6 33.5 34.2 34.9 35.6 36.2 36.9 37.6 38.2 38.8 39.4 40.0 40.6 41.2 41.8 42.4 42.9 43.5 44.0 44.5 45.0 45.5 46.8 48.0 49.1 50.2 51.2 52.2 56.7 60.5 66.5 1.05
1.10 12.6 15.4 18.0 20.6 23.0 25.3 27.5 29.6 31.6 33.5 35.4 36.1 36.7 37.4 38.1 38.7 39.3 40.0 40.6 41.2 41.8 42.3 42.9 43.5 44.0 44.5 45.1 45.6 46.1 46.6 47.1 48.3 49.4 50.5 51.6 52.6 53.5 57.9 61.5 67.2 1.10
1.15 14.4 17.2 20.0 22.5 25.0 27.3 29.5 31.6 33.6 35.4 37.2 37.9 38.6 39.2 39.9 40.5 41.1 41.7 42.3 42.9 43.5 44.0 44.6 45.1 45.6 46.2 46.7 47.2 47.7 48.2 48.6 49.8 50.9 51.9 52.9 53.9 54.9 59.0 62.5 68.0 1.15
1.20 16.2 19.1 21.9 24.5 27.0 29.3 31.5 33.6 35.5 37.3 39.1 39.7 40.4 41.0 41.7 42.3 42.9 43.5 44.0 44.6 45.1 45.7 46.2 46.7 47.3 47.8 48.3 48.7 49.2 49.7 50.1 51.3 52.3 53.3 54.3 55.2 56.1 60.2 63.5 68.8 1.20
1.25 18.1 21.1 23.9 26.5 29.0 31.3 33.5 35.5 37.4 39.2 40.9 41.5 42.2 42.8 43.4 44.0 44.6 45.2 45.7 46.3 46.8 47.3 47.8 48.4 48.8 49.3 49.8 50.3 50.7 51.2 51.6 52.7 53.7 54.7 55.7 56.6 57.4 61.3 64.5 69.6 1.25
1.30 20.0 23.0 25.9 28.5 31.0 33.3 35.4 37.4 39.3 41.0 42.7 43.3 43.9 44.5 45.1 45.7 46.3 46.8 47.4 47.9 48.4 48.9 49.4 49.9 50.4 50.9 51.3 51.8 52.2 52.7 53.1 54.1 55.1 56.1 57.0 57.9 58.7 62.4 65.5 70.4 1.30
1.35 21.9 25.0 27.9 30.5 33.0 35.2 37.3 39.3 41.1 42.8 44.4 45.1 45.7 46.3 46.8 47.4 47.9 48.5 49.0 49.5 50.0 50.5 51.0 51.5 52.0 52.4 52.9 53.3 53.7 54.1 54.6 55.6 56.5 57.4 58.3 59.1 59.9 63.5 66.5 71.1 1.35
1.40 23.9 27.0 29.9 32.5 34.9 37.1 39.2 41.1 42.9 44.6 46.2 46.8 47.4 47.9 48.5 49.0 49.6 50.1 50.6 51.1 51.6 52.1 52.6 53.0 53.5 53.9 54.3 54.8 55.2 55.6 56.0 56.9 57.9 58.7 59.6 60.4 61.2 64.6 67.5 71.9 1.40
1.45 25.8 29.0 31.9 34.5 36.9 39.1 41.1 43.0 44.7 46.4 47.9 48.5 49.0 49.6 50.1 50.7 51.2 51.7 52.2 52.7 53.2 53.6 54.1 54.5 55.0 55.4 55.8 56.2 56.6 57.0 57.4 58.3 59.2 60.0 60.9 61.6 62.4 65.7 68.4 72.7 1.45
1.50 27.8 31.0 33.8 36.4 38.8 40.9 42.9 44.8 46.5 48.1 49.6 50.1 50.7 51.2 51.8 52.3 52.8 53.3 53.7 54.2 54.7 55.1 55.6 56.0 56.4 56.8 57.2 57.6 58.0 58.4 58.8 59.7 60.5 61.3 62.1 62.9 63.6 66.8 69.4 73.5 1.50
1.55 29.8 33.0 35.8 38.4 40.7 42.8 44.8 46.6 48.2 49.8 51.2 51.8 52.3 52.8 53.3 53.8 54.3 54.8 55.3 55.7 56.2 56.6 57.0 57.4 57.8 58.2 58.6 59.0 59.4 59.7 60.1 61.0 61.8 62.6 63.3 64.1 64.7 67.8 70.3 74.3 1.55
1.60 31.8 35.0 37.8 40.3 42.6 44.6 46.5 48.3 49.9 51.4 52.8 53.4 53.9 54.4 54.9 55.4 55.9 56.3 56.8 57.2 57.6 58.0 58.5 58.9 59.2 59.6 60.0 60.4 60.7 61.1 61.4 62.3 63.1 63.8 64.5 65.2 65.9 68.8 71.3 75.1 1.60
1.65 33.8 36.9 39.7 42.2 44.4 46.4 48.3 50.0 51.6 53.1 54.4 54.9 55.4 55.9 56.4 56.9 57.3 57.8 58.2 58.6 59.1 59.5 59.9 60.2 60.6 61.0 61.4 61.7 62.1 62.4 62.7 63.5 64.3 65.0 65.7 66.4 67.0 69.9 72.2 75.9 1.65
1.70 35.8 38.9 41.6 44.0 46.2 48.2 50.0 51.7 53.2 54.7 56.0 56.5 57.0 57.5 57.9 58.4 58.8 59.2 59.7 60.1 60.5 60.9 61.2 61.6 62.0 62.3 62.7 63.0 63.4 63.7 64.0 64.8 65.5 66.2 66.9 67.5 68.2 70.9 73.1 76.6 1.70
1.75 37.7 40.8 43.5 45.9 48.0 50.0 51.7 53.4 54.8 56.2 57.5 58.0 58.5 58.9 59.4 59.8 60.2 60.7 61.1 61.5 61.8 62.2 62.6 62.9 63.3 63.6 64.0 64.3 64.6 64.9 65.3 66.0 66.7 67.4 68.0 68.7 69.2 71.9 74.0 77.4 1.75
2.00 47.3 50.1 52.5 54.6 56.5 58.2 59.7 61.1 62.4 63.6 64.6 65.0 65.4 65.8 66.2 66.6 66.9 67.3 67.6 67.9 68.3 68.6 68.9 69.2 69.5 69.8 70.0 70.3 70.6 70.8 71.1 71.7 72.3 72.9 73.4 73.9 74.4 76.5 78.3 81.0 2.00
2.25 56.1 58.6 60.7 62.5 64.1 65.6 66.8 68.0 69.1 70.0 70.9 71.3 71.6 71.9 72.2 72.5 72.8 73.1 73.4 73.7 73.9 74.2 74.4 74.7 74.9 75.2 75.4 75.6 75.8 76.0 76.3 76.8 77.2 77.7 78.1 78.5 78.9 80.6 82.1 84.3 2.25
2.50 64.0 66.1 67.9 69.4 70.8 72.0 73.1 74.0 74.9 75.7 76.4 76.7 77.0 77.2 77.5 77.7 78.0 78.2 78.4 78.7 78.9 79.1 79.3 79.5 79.7 79.9 80.0 80.2 80.4 80.6 80.7 81.1 81.5 81.9 82.2 82.6 82.9 84.3 85.4 87.2 2.50
2.75 70.9 72.7 74.2 75.4 76.6 77.5 78.4 79.2 79.9 80.5 81.1 81.4 81.6 81.8 82.0 82.2 82.4 82.6 82.7 82.9 83.1 83.3 83.4 83.6 83.7 83.9 84.0 84.2 84.3 84.4 84.6 84.9 85.2 85.5 85.8 86.0 86.3 87.4 88.3 89.7 2.75
3.00 76.9 78.3 79.5 80.5 81.4 82.2 82.9 83.5 84.1 84.6 85.1 85.3 85.4 85.6 85.8 85.9 86.1 86.2 86.4 86.5 86.6 86.8 86.9 87.0 87.1 87.3 87.4 87.5 87.6 87.7 87.8 88.1 88.3 88.5 88.8 89.0 89.2 90.0 90.7 91.8 3.00
3.50 86.0 86.9 87.6 88.3 88.8 89.3 89.7 90.1 90.5 90.8 91.1 91.2 91.3 91.4 91.5 91.6 91.6 91.7 91.8 91.9 92.0 92.1 92.1 92.2 92.3 92.4 92.4 92.5 92.6 92.6 92.7 92.8 93.0 93.1 93.3 93.4 93.5 94.0 94.4 95.1 3.50
4.00 92.0 92.5 92.9 93.3 93.6 93.9 94.2 94.4 94.6 94.8 94.9 95.0 95.0 95.1 95.2 95.2 95.3 95.3 95.4 95.4 95.4 95.5 95.5 95.6 95.6 95.7 95.7 95.7 95.8 95.8 95.8 95.9 96.0 96.1 96.2 96.2 96.3 96.6 96.8 97.2 4.00
4.50 95.7 96.0 96.2 96.4 96.6 96.7 96.9 97.0 97.1 97.2 97.3 97.3 97.3 97.4 97.4 97.4 97.5 97.5 97.5 97.5 97.6 97.6 97.6 97.6 97.6 97.7 97.7 97.7 97.7 97.8 97.8 97.8 97.9 97.9 97.9 98.0 98.0 98.2 98.3 98.5 4.50
5.00 97.8 97.9 98.1 98.2 98.3 98.3 98.4 98.5 98.5 98.6 98.6 98.6 98.6 98.7 98.7 98.7 98.7 98.7 98.7 98.7 98.8 98.8 98.8 98.8 98.8 98.8 98.8 98.8 98.8 98.9 98.9 98.9 98.9 98.9 99.0 99.0 99.0 99.1 99.1 99.2 5.00
6.00 99.5 99.5 99.6 99.6 99.6 99.6 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.7 99.8 99.8 99.8 99.8 99.8 99.8 99.8 99.8 99.8 99.8 99.8 6.00

Note: Values in the table represent percentages of underlying asset values: e.g., 39.3 denotes a call option worth 39.3% of the underlying asset value.
Values in the table were computed from the Black-Scholes option pricing model.
The format of the table was adapted from Brealey and Myers, Principles of Corporate Finance, 4th edition, McGraw-Hill, Inc., New York, 1991, Appendix Table 6, pp. AP12-13.