Valuation of a Project Investment Using Black–Scholes model

Question

"When you have the option of deciding when to invest, it is usually optimal to invest when the NPV is substantially greater than zero.”

Your Company Plc is considering a new project at a cost of £13 million. The project may begin today or in exactly one year. You expect the project to generate £2,000,000 in free cash flow the first year if you begin the project today. Free cash flow is expected to grow at a rate of 3% per year. The risk-free rate is 4%. The appropriate cost of capital for this investment is 11%. The standard deviation of the project’s value is 30%.

The Black–Scholes model introduced standard options pricing method which is very useful among users in financial market and companies. However, the model disagrees with reality in a number of ways. Hence, proper use requires understanding its limitations.

With reference to above, explain Black and Scholes model and its limitations reviewing published journal articles

Summary

The question belongs to financial management and it discusses about calculating NPV, IRR, Payback period, etc for a company using Black–Scholes model

Total Word Count 151